Understanding ‘Increasing Returns to Scale and Economic Geography’: Part I: A Graphical Exposition ; Part II: An Analytical Solution

Abstract part I: This paper provides a simple graphical exposition and a rigorous analytical method for monopolistic competition, increasing returns to scale, geography and trade models with transport costs which explain agglomeration or convergence of industries. In the main text, the agglomeration and convergence forces are graphically exposed, whereas the appendix provides the analytical treatment of the model. New light is shed on the Dixit-Stiglitz-Krugman model by an analogy to a heterogeneous agent pure exchange economy.

Abstract part II: This paper provides an analytical solution to the Krugman (1991a) model explaining industry agglomeration. It is shown there exists a unique short-run equilibrium and multiple long-run equilibria. The latter proves the existence of a “poverty trap” in this model: depending on the initial level of industries we will either see industries spreading evenly in the plane, or moving away from one of the regions. However, it is also shown that this “poverty trap” will not appear if the economy starts developing from an equal distribution of industries.