Elastic Labor Supply, Variable Markups, and Spatial Inequalities

Abstract

Assuming an inelastic labor supply, existing studies on spatial inequalities across countries show that a larger country has the advantages of a higher wage rate and a higher individual income. This paper reexamines these results by use of a model with an endogenous labor supply and variable markups. We find that both advantages can be reversed. Specifically, if the love for variety is strong and trade costs are high, the wage rate is lower but the individual income is higher in the larger country. However, if the love for variety is weak and trade costs are low, the wage rate is higher but the individual income may be lower in the larger country.

Keywords: Elastic Labor Supply, Variable Markups, Wage Rate, Income, Home Market Effect

JEL Classification: F12, F21, R12