Fiat Chrysler Automobiles FCAU 1.44% NV plans to spend $4.5 billion to expand factory production in Michigan, including a new Jeep assembly plant in Detroit, but also said Tuesday it will lay off workers at a plant in Illinois.

The auto maker is adding 6,500 new jobs in Michigan as part of a restructuring of its manufacturing operations that started under the leadership of Sergio Marchionne, who died in July, and is continuing under new Chief Executive Mike Manley.

Fiat Chrysler, the third largest U.S. auto maker by sales, is investing billions to retool its existing factories in the state to assemble more SUVs and pickup trucks, aiming to boost profits with sales of more-lucrative models in the U.S. The plan also reflects a shift in consumer demand away from small cars and sedans.

At the same time, the company said it is eliminating 1,370 jobs at its factory in Belvidere, Ill., where it builds the Jeep Cherokee compact SUV. A Fiat Chrysler spokeswoman said the cuts, scheduled for May, are part of an effort to better align production with demand for the model in the U.S. and globally. The Illinois plant will continue to build the Cherokee on two shifts.

The Italian-American auto maker intends to spend $1.6 billion to build the new Detroit plant, converting a site now used for engine manufacturing into a vehicle assembly complex that will build the next-generation Jeep Grand Cherokee and a new large Jeep SUV that has yet to hit the market.

The Wall Street Journal reported Fiat Chrysler’s plans to open a vehicle plant in Detroit in December.

President Trump has chastised both foreign and domestic car makers for not investing enough in the U.S. to create new manufacturing jobs. In recent months, he criticized General Motors Co. for its plans to close four U.S. factories, including a vehicle assembly plant in Detroit, and told GM’s chief executive to stop building cars in China. GM executives have said the plant closures are part of a broader restructuring aimed at reducing costs ahead of an expected slowdown in the U.S. car market.

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Fiat Chrysler won praise from Mr. Trump last year when the auto maker said it would invest $1 billion to shift some pickup production from Mexico to Michigan. The company reversed its decision Tuesday, saying that to allow more space for Jeep production it no longer plans to shift output of Ram Heavy Duty trucks to Michigan.

The company’s moves come even as U.S. auto sales are cooling after more than a half-decade of robust growth, and as rival auto makers are trimming their sails to ride out a downturn while also investing in new technologies, such as electric and self-driving cars.

“Economic indicators as we see them are still strong,” Mr. Manley said of the U.S. car market, in a conference call with reporters Tuesday.

Even if the market cools, he said, the new large Jeep SUV coming from the new plant in Detroit will fit a category now in high demand.

“This is an investment that is necessary to make sure that we retain this competitive nature,” Mr. Manley said, referring to the market for SUVs.

The company says it intends to start construction on the new Detroit factory this year and will begin building vehicles at the plant in late 2020, creating 3,850 jobs. Under the terms of the agreement, the city of Detroit will acquire 200 acres for the new plant within 60 days.

The last time a domestic auto maker opened a new assembly factory in the U.S. was before the recession, when GM built a plant in Lansing, Mich., in 2006.

Fiat Chrysler also said it would spend $900 million to modernize its Jefferson North plant in Detroit, creating 1,100 new jobs at that plant. A previously announced investment in its Warren, Mich., truck assembly plant would increase to $1.5 billion from $1 billion, with more than 1,000 jobs being created.

Fiat Chrysler’s announcement comes ahead of contract talks starting this summer between the United Auto Workers union and the Detroit car makers. The companies typically use the prospect of new factory jobs as leverage in their talks with union bargainers.

Mr. Manley, who ran the Jeep and Ram brands before taking the helm last summer, sees extending those lines as key to sustaining the company’s recent profit growth.

As part of its five-year plan, the company plans to add new SUV models to Jeep’s lineup, including a small SUV and a three-row version of the Grand Cherokee, along with reviving the Wagoneer and Grand Wagoneer. Fiat Chrysler will also produce plug-in hybrid versions of certain Jeep models at three Michigan plants, with the flexibility to build fully electric Jeep models in the future.

While the auto maker has added workers and expanded operations at existing plants to boost output, the last time it built a vehicle factory in the U.S. was in 2005 in Toledo, Ohio, to assemble the popular Jeep Wrangler.

During its 2009 bankruptcy, Chrysler Group LLC—the U.S. car company that eventually combined with Italy’s Fiat SpA to create Fiat Chrysler—closed three assembly plants and laid off thousands of workers.

Since then the company has opted to run its factories at full throttle, rather than build new plants—a course taken by Volkswagen AG, Toyota Motor Corp. and other foreign-based competitors.

“Their plants are running extremely lean and efficient,” said Jeff Schuster, president of global forecasting at LMC Automotive. “Fiat Chrysler shifted to trucks ahead of the market going in that direction and they are reaping the benefits.”

Write to Adrienne Roberts at Adrienne.Roberts@wsj.com