A Spatial Theory of Trade

The equilibrium relationship between trade and the spatial distribution of economic activity is fundamental to an analysis of the effect of trade policy and other trade frictions. We study this link using a trade model with a continuum of regions, transport costs, and agglomeration effects via production externalities. We analyze the equilibrium specialization and trade patterns for different levels of transport costs and show that the theory is consistent with evidence from estimations of the Gravity Equation. The effect of trade barriers is amplified by changes in specialization patterns thereby producing important border effects, as documented in the empirical literature.