This paper investigates firms’ optimal location choices explicitly accounting for the role

of inwards and outwards knowledge spillovers in a dynamic Cournot oligopoly with firms

that are heterogeneous in their ability to carry out cost-reducing R&D. Firms can either locate

in an industrial cluster or in isolation. Technological spillovers are exchanged between

the firms in the cluster. It is shown that a technological leader has an incentive to locate

in isolation only if her advantage exceeds a certain threshold, which is increasing in firms’

discount rate, in industry dispersion, and in the intensity of knowledge spillovers. Scenarios

are identified where although it is optimal for the technological leader to locate in isolation,

from a welfare perspective it would be desirable that she locates in the cluster.