Evidence on the Determinants of Foreign Direct Investment: The Case of Three European Regions

π_e = (p_i -w_iβ)c_ijT_ij.

According to Dixit-Stiglitz (1977), by maximizing the profit function, the firm can fix the
selling price as :

and by replacing (4) into (3) we get the final expression for the profit when the firm decides to
export from region i to region j:

When the firm settles in the final market rather then exporting, the production function
changes, since building a plant in region j implies plant specific fixed costs (α). Therefore, when the
firm makes a direct investment region j, the production function becomes

Lj= αj + βyj. For the sake of simplicity, we assume that the marginal cost of labor is equal in both
regions, but fixed costs and wages can differ. In fact, when producing directly in the host region, the
firm pays the workers the wage wj. In the case of direct investment in region j, the demand for the
variety of the good produced by the firm we are considering turns out to be:⁴

(n V^σ ( Y А

j Yt-

к ^jJ к ^jJ

As before, the firm fixes the selling price by maximizing its profit function (pj yj - wj Lj) as in
Dixit-Stiglitz (1977), and it is equal to:

Hence, the final profit that a firm obtains by investing directly in region j is the following:

A firm will establish a plant in region j rather than exporting when the profit is higher in the
first option, namely when:

⁴ There is no transport cost when producing and selling locally.

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