where Ui and Si represent respectively the share of total low and high-skilled workers
population, which live in region i.
It is important to note that the number of skilled workers, as a fraction of the total
manufacturing labour force, is exogenously determined.9
3.3 Production technology
Agriculture is a constant return to scale, perfectly competitive sector. We normalise the
unitary labour input requirement to 1. Agricultural products are freely traded and therefore
agricultural prices and wages are equalised across regions and shall be our numeraire.
Consequently, PA = wA = 1 in both regions.
The production of any variety of the manufactured good involves a fixed and a
constant marginal cost:
li= α + βxi (13)
where xi is the quantity produced and li the labour requirement for its production. Because of
economies of scale at firm level and consumers’ preferences for variety, firms produce a
single product facing an elasticity of demand equal to σ.
Imported manufacturing varieties incur Samuelson iceberg trade costs. If a variety is shipped
from one region to the other, part of each unit melts away during the transport, therefore only
a fraction 1Zτ arrives at destination.10 The introduction of this kind of trade costs implies that,
if a variety is produced in region 1, consumers in the two different regions have to pay
9 In subsequent research, we consider the worker’s human capital investment decision and the role of public
policy.
15
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