results step by step. Section 2 presents the basic NEG-model with tariffs
on the two considered industries, a competitive sector and a monopolistic
sector. Section 3 analyzes briefly, as a reference case, the standard outcome
if policy is inactive. Section 4 starts the policy analysis by the assumption
that regions do not cooperate and follow the goal of maximizing only their
own welfare. Contrastly, section 5 analyzes the optimal policy in case of
cooperation. But, compared with the no-cooperation case the aggregated
welfare gain can be distributed unevenly across both regions. In order to
avoid these regional welfare losses section 6 derives the necessary transfers to
sustain at least the welfare level of the no-cooperation case for each region.
Finally, section 7 analyzes the consequences of the derived policies for the
long-run income convergence and how the sustainability of core-periphery
equilibria is affected. Section 8 concludes.
2 The model
The model of this section bases on a general 2-region-agglomeration model
of Forslid (1999) which is an analytically solvable version of the original
core-periphery model of Krugman (1991). The innovation of the model is
the additional consideration of tariffs and taxes by which governments may
achieve the goals of welfare optimizing and income convergence. The main
distinction between tariffs and other trade costs is that tariffs generate gov-
ernment revenues while other trade costs, modeled as iceberg type, imply
only costs with no corresponding income.
There are two symmetric regions called home and abroad. Symmetry
of both regions guarantees that, with the notational exception of an aster-
isk, most equations describing foreign behavior are similar to corresponding
domestic equations. Therefore, the model is presented mainly from the do-
mestic perspective and corresponding foreign equations are illustrated only
if necessary.
The economy in both regions consists of two sectors, a competitive sector,