named agriculture, producing a homogeneous good A under constant returns
of scale (CRS) and a monopolistic sector, named industry, producing differ-
entiated varieties, xi, under increasing returns to scale (IRS). All available
varieties from both regions are combined to a composite good X which is
consumed according to the preferences
n n+n*
U = XγA1-γ, X =
ʃ xi1-σ di
(1)
i=0
where n and n* denote the number of domestic and foreign firms and σ the
constant elasticity of substitution between varieties. All firms within each
region face identical demand and supply conditions such that optimal in-
and output decisions will be identical within each region. Therefore, and for
simplicity the subscript i is neglected in the following.
There are two input factors of production, unskilled and skilled labor.
Unskilled labor is immobile between both regions and to guarantee symmetry
the unskilled labor supply of each region is normalized to one. Aggregated
skilled labor supply is normalized to one, too, but, in contrast to unskilled
labor, mobile between both regions following real wage differences. Therefore,
in case of full employment L skilled are employed in the domestic region and
L*=1-L skilled are employed in the foreign region.
The homogenous agricultural good A is produced with the only input
unskilled labor and marginal cost of unity. Since competition guarantees
zero profits and agricultural goods are traded for free producer prices of
unity hold in both regions. Consumer prices, in contrast, may differ between
both regions according to corresponding taxes and tariffs. For simplicity only
regional taxes tA and t*A on agricultural consumption are considered. But,
since the agricultural good is homogeneous, the impact of a tax is very similar
to the impact of a tariff. Both instruments raise consumer prices by the same
size and the only difference is that rents created by a tariff are separated in
producer rents and government revenues while taxes create only government
revenues. The value of all rents is equal for both instruments such that
regional welfare is unaffected by the choice of the instrument. Therefore
and since the objective of this paper is rather an analysis of regional welfare