Country 1, ∆ Real wages
9
8
7
6
5
4
3
τ (%)
γ
10 60
Country 2, ∆ Real wages
0
-0.5
-1
-1.5
-2
-2.5
10
60
0
γ τ (%)
Figure A5: Change in real wages [on the vertical axis] as a function of trade costs and
the shape parameter of the Pareto distribution for a given change of b1 from 0.4 to 0.8.
Result A6a [Spill-overs in the Krugman economy]
If firms are homogenous and external economies of scale are important (ν = 1), then an
increase of unemployment benefits in country 1 leads to a decrease of real wages in all
countries.
The increase in unemployment is accompanied by a loss in real wages in all countries,
as is shown in Figure A6. The main reason here is that due to less varieties and higher
prices, the overall price level rises. This is a result of the external economies of scale. As
in the Krugman model with perfect labor markets, larger markets imply lower prices and
higher real wages. Hence, if unemployment goes up, the opposite effects occur.
Result A6b [Spill-overs in the Krugman economy without external economies
of scale]
If firms are homogenous and there are no external economies of scale (ν = 0), an increase
in unemployment benefits in one country will have ambiguous wage effects in that country
while in all other countries wages increase.
Figure A7 plots real wages when firms are homogenous and external economies of scale
are not important. In this case, the effects on real wages for country 1 are ambiguous.
On the one hand, home varieties become relatively more expansive as foreign varieties,
implying higher costs of living, and hence, lower real wages. On the other hand, higher
unemployment benefits lead to higher equilibrium bargained nominal wages. The net
effect is ambiguous. For the trading partner, the compositional effect implies a gain
in attractiveness, leading to relative lower prices for home varieties relative to foreign
varieties. This leads to a fall of the costs of living and therefore to higher real wages.
Note that this compositional effect again vanishes as for unemployment if all varieties
enter the price index symmetrically, which is the case when trade costs are zero. Hence,
real wages do not change at all if τ = 1.
55