Revisiting “On nations’ size and transportation costs”

In international trade as well in the "New Economic Geography", country size is represented solely by the size of the country's population. A notable exception is the paper by Shachmurove and Spiegel (1995). Applying the Hotelling model to international trade and using the geographical interpretation of the Hotelling line, the authors propose a model where countries differ not only in population size but also in terms of their geographical extent. However, under certain assumptions on the locations of the firms, a pure strategy Nash equilibrium does not exist. In this paper, an alternative way to circumvent this existence problem and to make the analysis possible is presented. The pure strategy Nash equilibrium is restored by changing the assumption on the pricing policies used by the firms. The analysis indicates that while the small country gains from free trade the overall welfare of the larger country is unaffected by the opening of the border. The analysis is also extended to include a discussion of the long run equilibrium locations of firms in the integrated market. The importance of both the population and the geographical size of the countries are shown to be determining in establishing the effect of free trade.