Central European University

I study knowledge spillovers in an industry where firms are mobile and heteroge-neous in their ability to adopt knowledge (absorptive capacity). I develop a model of in-dustry agglomeration in which an attraction force induced by spillovers is counteracted by a force created by local competition. I apply the model to the US software indus-try and obtain the following results: the data supports localized knowledge spillovers; firms that have higher absorptive capacity are sorted into more agglomerated counties; ignoring firm heterogeneity leads to biased estimates of gains from spillovers; spillovers play a modest role in explaining the geographic distribution of firms. ∗This paper is based upon a chapter of my Penn State University Ph.D. thesis. I am grateful to Kala Krishna and Joris Pinkse for their invaluable advice and support. I also would like to thank Saroj Bhattarai