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force. In particular, let n be the number of manufactured varieties produced in the economy as a whole,
and let n j be the number produced at location j. Then we have
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Equation (14) plays a crucial role in the whole analysis in this approach. The logic of the model
depends crucially on increasing returns, yet as we write out the equations of short-run equilibrium these
increasing returns will not be very visible. Where did they go? The answer is that they are hidden in
(14). What increasing returns do is to make it profitable to produce each variety in only one location, so
that different locations do not produce the same set of goods but differentiated bundles of products.
When a location gains labor it does not produce more of the same mix of products, but adds new
products. This "quantization" of production is the only way in which increasing returns actually enter
the solution, but it is enough: as we will see, the micro assumption does indeed have major macro
effects.
There are now several ways to proceed. The one that seems easiest represents short-run equilibrium as
the solution of four sets of equations.
First, we determine income at each location. Given our assumption of zero transport costs on
agricultural goods, the wage rate of farmers is the same at all locations. Let there be workers and 1 - µ
farmers, a normalization that will set economywide income equal to 1; and let us measure all prices and
wages in terms of the agricultural good. Then we have
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