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Can Information Asymmetry Cause Agglomeration?

Berliant, Marcus and Kung, Fan-chin (2006): Can Information Asymmetry Cause Agglomeration?

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Various models, such as those used in the New Economic Geography literature, employ combinations of agglomerative and repulsive forces to generate equilibria with cities and agglomeration. Can classical asymmetric information in the labor market, in the form of adverse selection, result in an equilibrium that features agglomeration of agents? We use a model with two types, high and low ability, and two locations. The high type dislikes work more than the low type. Firms in both locations have the same technology for production of a single consumption commodity that depends on the type of worker employed. They know the distribution of types, but the type of a particular worker is private information to that worker. The firms compete with both potential entrants and firms in the other location. Firms offer labor contracts that specify wages based on hours worked. In equilibrium, zero profit, voluntary participation, and incentive compatibility constraints must be satisfied along with feasibility. A further stability requirement is imposed, that the equilibrium be immune to small locational deviations of consumers. We have functional forms and some relatively mild restrictions on parameters such that the equilibrium separates types by location. Thus, high and low skilled workers agglomerate separately. This can be induced as a comparative static change from a symmetric equilibrium to an asymmetric one by varying some of the exogenous parameters.

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