The zero-profit condition implies that in equilibrium revenues equal costs.
This condition fixes each firms output to x = σw, while each firm employs
(σ - 1)w unskilled employees and one skilled employee.
Nominal regional income Y consists of three components, wage income of
the unskilled and skilled workers as well as government income G:
Y = 1 + Lw + G. (4)
Government income can be separated further in tariff revenues GI from im-
ported varieties and tax revenues GA from agricultural consumption. Tariff
revenues can be derived by determining the import demand from the utility
(1), using the producer price of p = 1 as well as trade costs τ . Since govern-
ment receives the share TI of the value of imported varieties, tariff revenues
are given by
Gi = Ti (1 -L)rθ=- P σ-1γY (5)
1 - TI
with Θ defined in (3). Agricultural tax revenues are easier to determine
since government receives the share TA of regional expenditure for agricul-
tural goods, namely GA = TA (1 - γ)Y. Combining tax and tariff revenues
government income is given by:
G = [t∣(1 - Z θ P' + Ta(1 - γ)1 Y (6)
1 - Ti
Since government income G depends on nominal income Y and vice versa
according to (4), both equations can be solved simultaneously for Y and G
to yield:
1 1-T
Y = T (1 + Lw), G = —T— (1 + Lw),
(7)
with T = 1 - Ti (I - L)-θ- P σ-1γ - Ta(1 - Y ).
1 - Ti
The parameter (1/T) denotes the factor by which nominal income is increased
by tariffs and taxes.