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CEP discussion paper
P Krugman and Anthony J. Venables
October 1993
Paper No' CEPDP0172:

The paper considers the equilibrium location of two industries in two countries. Both industries are imperfectly competitive and produce goods which are used in final consumption and as intermediates by firms in the same industry. Intermediate useage creates cost and demand linkages between firms and a tendency for agglomeration of each industry. When trade barriers are high the equilibrium involves division of both industries between both locations in order to meet the final demands of consumers. At lower trade barriers agglomeration forces dominate the equilibrium involves specialisation, with each industry concentrated in a single location. Economic integration may induce specialisation. The paper studies the simple dynamics of the model and demonstrates that during adjustment processes a sizable proportion of the labour force may suffer lower real wages as relocation of industry occurs, although there are long run gains from integration.