A Model of Firms' Decisions to Export or Produce Abroad

This paper is a theoretical analysis of the factors influencing production location decisions by a multinational corporation. It starts with a simple model of optimization for a firm facing the choice between exporting and producing abroad a single differentiated final product and then develops the model to take account of production of intermediate as well as final products, the existence of scale economies, and finally, the effects of transport cost and of factors affecting the cost of production. The share of foreign output is shown to be related to the level of transport cost, to the size of host-country markets, to host-country wage levels relative to those of the home country, in combination with labor intensities of production. All of these relationships in turn are shown to interact in various ways with economies of scale in affecting the choice of production locations.