differentiated intermediate good industry. Workers are geographically immobile but perfectly mobile across industries. The final industry uses labor and a continuum of intermediates. The latter are produced using labor only. Both final and intermediate goods can be shipped at a transport cost _t_ between domestic regions, and at a trade cost _τ_ between domestic regions and the rest-of-the-world. A mass _fR_ of intermediates are imported from abroad. As transport and trade costs change, so do the prices of final and intermediate goods, as well as the trade patterns and firm sizes. Furthermore, changes in _t_ and _τ_ affect the masses of final firms ( _Nr_ and _Ns_ ) and the masses of intermediate firms ( _nr_ and _ns_ ) located in each region. In other words, the spatial structure of economic activity changes as the costs of trading goods domestically and internationally change.

Although the model is highly stylized, it is rich enough to preclude a full analytical investigation. Solving it explicitly and deriving paper-and-pencil comparative static results is, therefore, beyond the scope of this paper. We hence simulate it to guide our empirical analysis. The simulations provide information on: (i) the expected sign of key coefficients; and (ii) what controls are required to isolate the key effect of interest, namely the relationship between changes in domestic transport costs and the spatial concentration of industries. One important question is how we can evaluate the latter. Because we use the count-based Duranton and Overman (2005) measure of geographic concentration in our empirical analysis – which is computed using the distribution of bilateral distances between plants (see the Supplementary Appendix S.1) – a natural counterpart in our simple model is the distribution of plants across Since the market has more – as it has a size – we measure regions. larger plants advantage the geographic concentration of industries by the share of plants located in the larger region in excess of that region’s share of total market size. Formally, we use the following measures: where _L_ = _Lr_ + _Ls_ is the total population; _N_ = _Nr_ + _Ns_ is the total mass of final firms; and _n_ = _nr_ + _ns_ is the total mass of intermediate firms. The first two measures in (1) capture the over-representation (positive values) or under-representation (negative values) of final and intermediate plants in the larger region. The last measure in (1) reports the same information for both industries jointly, i.e., the aggregate spatial distribution of economic activity.

The key question of interest is how the geographic concentration of both industries across regions, as measured by (1), changes with _t_ and _τ_ . Table 1 below summarizes a series of results for different sets of parameter values of the model.

As can be seen from the top panel (a) of Table 1, decreasing domestic transport costs _t_ lead to the geographic concentration of the final goods sector (column 1), slightly more geographic dispersion of the intermediate sector (column 2), and more geographic concentration overall (column 3). As can be seen from the middle panel (b), decreasing international trade costs _τ_ have the opposite effect. They lead to more geographic dispersion of the final good sector 4