A spatial equilibrium model of local nonmarket production with capacity constraints

This paper studies the autonomous formation of regions with local nonmarket production in the presence of profit-maximizing producers. The approach is based on a spatial equilibrium model with a linear transport cost. A Hotelling duopoly model is extended by allowing the households, uniformly distributed on a line, to become local producers. Due to capacity restrictions, local production covers at most a given percentage of a fixed household demand, whereas the remaining portion is bought from one of the profit-maximizing suppliers. Local production is pro-competitive, implying a lower equilibrium price than the standard Hotelling model, in spite of capacity restrictions. A price equilibrium where the firms are located symmetrically within the quartiles may exist, assuming a sufficient degree of self-sufficiency of local production. A higher level of capacity restrictions implies a higher equilibrium price. Local production may emerge as an equilibrium outcome, assuming the production does not require strong economies of scale and assuming the households are willing to invest in local production. Due to imperfect competition, the equilibrium number of local producers is positive whenever local production is optimal. Copyright Springer-Verlag Berlin Heidelberg 2015