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Document Finally, we note that (21) may be rewritten as If (25) Page 103 then as τ grows the real wage in location 2 eventually must exceed 1. In that case the relationship between transport costs and the real wage must have the shape illustrated by the curve in figure A.1. At high transport costs a concentration of production is not sustainable; there is a range of low transport costs for which such a concentration is not sustainable. If (25) is not satisfied, the curve lies below 1 for all values of τ. To understand this case, we note that σ/ (σ-1) is the ratio of price and hence average cost to marginal cost, a measure of equilibrium economies of scale. Thus (25) amounts to saying that neither the share of manufacturing in the economy nor economies of scale are too large. If scale economies and the manufacturing share are sufficiently large, workers will prefer to cluster together even with prohibitive transport costs. Returning to the case where (25) is satisfied, we note that what we have defined is a critical value of τ, τ* below which concentration is an equilibrium. We may offer some rough intuition here by stepping a bit outside the formal model. Basically, when transport costs are sufficiently low it is worthwhile for manufacturers to concentrate their production geographically so as to realize economies of scale. Once they have decided to concentrate production, however, the optimal location is one that other producers file:///D|/Export3/www.netlibrary.com/nlreader/nlreader.dll@bookid=409&filename=page_103.html [4/18/2007 10:31:52 AM]
Document Figure A.1 have also chosen. So low transport costs foster agglomeration. Page 104 One might expect that concentration would also be more likely the higher is µ . It is straightforward to show (see Krugman 1991) that Let us also bear in mind that , the elasticity of substitution, is inversely related to the equilibrium degree of economies of scale. Thus we would expect to find that a high elasticity of substitution works against agglomeration, and we can indeed show (again see Krugman 1991) that file:///D|/Export3/www.netlibrary.com/nlreader/nlreader.dll@bookid=409&filename=page_104.html [4/18/2007 10:31:52 AM]
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