Economic Development and Capital Mobility under Marshallian Externality

Abstract

Krugman showed the uneven development in his North-South model assuming increasing return production technology. Though his theory was very exciting, it was not based on strict microeconomic foundations. The purpose of this paper is to reexamine his theory assuming profit-maximizing behavior of individuals.We assume that each firm faces the decreasing-return technology. However, due to the existence of the Marshallian external effect, the social production technology exhibits increasing return. Even though following the Krugman's line, i.e., the increasing-return production technology, we can derive the optimal level of investment of each individual by her maximization behavior.We assume that one can invest her capital in whatever regions or firms where the rate of return is higher. Under a mild assumption, thus determined short-run equilibrium is stable, where each firm has the same amount of capital, since we assume that the production technology of each firm is homogeneous.Next, we consider the dynamic behavior of the economy. When we assume that, on the balanced growth path, the marginal product of capital of each firm is decreasing, we can derive that the long-run equilibrium is stable and each firm is homogeneous. But the number of the firms in each region is not determined. We also derived the possibility of uneven development, i.e., the firm of those regions are not homogeneous and capital concentrates to one region in the long run when we abandon the assumption stated in the above.