DP1845 | Agglomeration and Endogenous Capital


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The ?new? economic geography focuses on the footloose-labour and the vertically-linked industries models. Both are complex, since they feature demand-linked and cost-linked agglomeration forces. The paper presents a simpler model, where agglomeration stems from demand-linked forces arising from endogenous capital with forward-looking agents. The model?s simplicity permits many analytic results (rare in economic geography). Trade-cost levels that trigger catastrophic agglomeration are identified analytically, liberalization between almost equal-sized nations is shown to entail ?near-catastrophic? agglomeration, and Krugman?s informal stability test is shown to be equivalent to formal tests in a fully specified dynamic model.