54th Congress of the European Regional Science Association: "Regional development & globalisation: Best practices", 26-29 August 2014, St. Petersburg, Russia
This paper develops a two-dimensional spatial framework to explore the firms' optimal locations and optimal attributes of basic products under linear transportation costs, in which firms have the technique of flexible manufacturing and engage in spatially discriminatory pricing. We can observe in the real world that the technique of flexible manufacturing has been widely adopted by most major manufacturing industries. As indicated by Eaton and Schmitt (1994), the key feature of flexible manufacturing is economies of scope, which can be represented by the production of an array of differentiated products extended by a basic product using the same manufacturing process. The production of the basic product incurs a sunk cost of product development, whose feature can be described by a point on Hotelling's attribute line. This basic product can be modified to produce extended variant products by incurring additional costs. The additional cost of producing an extended variant product is denoted by a per-unit modification cost that is proportional to the distance of the attribute line between the attribute addresses of the basic product and the extended variant product. The game in question is a three-stage game. Firms simultaneously select their equilibrium locations in the first stage. Then, they simultaneously choose the optimal attributes of the basic products in the second stage. Finally, firms engage in spatially discriminatory pricing in the third stage. The main findings of the paper are as follows. First of all, we show that the two firms will agglomerate at the center of the location line and the optimal attributes of the two basic products will be located at the first and third quartiles of the attribute line, respectively, when the ratio of the marginal modification rate to the transport rate is high. Secondly, the two firms will locate separately on the location line and the optimal attributes of the two basic products will remain at the first and third quartiles when this ratio is moderate. Moreover, the two firms will locate at the first and third quartiles of the location line, respectively, and the optimal attributes of the basic products will agglomerate at the center of the attribute line when this ratio is low.