Abstract

This paper investigates the relationship between market potential and the spatial variation in the number and the average size of firms. We adapt the canonical model of the New Economic Geography to demonstrate this relationship and to derive an empirical specification suitable for estimation through dynamic panel techniques. The model is tested against municipal data on the number of firms per adult in Chilean comunas for 2005-2010. Our results confirm that market potential along with place-specific fixed costs play an important role in determining the spatial variation in the number of firms per capita.