Home Market Effects : Beyond the Constant Elasticity of Substitution

This paper aims to fill the gap between theoretical and empirical studies of home market effects (HMEs). On one hand, empirical studies on the price aspect of HMEs -- that wages are higher in larger markets -- are supportive, but studies on the quantity aspect -- that the firm share in the larger market is more than proportionate -- are highly mixed. On the other hand, most existing theoretical studies support the quantity aspect but neglect the price aspect. By using a general utility function that captures the pro-competitive effect and the income effect together in a footloose capital model, we re-examine both the price and quantity aspects of HMEs. The new theoretical results are consistent with the empirical studies