Knowledge Goods, Ordinary Goods, and the Effects of Trade between Leading and Lagging Regions

We study the effects of trade in knowledge and ordinary goods on the income and welfare gap between a leading and a lagging region. Knowledge goods are invented and produced in the leading region only. In contrast, ordinary goods can be produced in both regions. Our analysis sheds light on four salient questions. First, we determine the equilibrium wage ratio between the leading and the lagging regions. Second, we show that increasing the rate at which the lagging region copies the technology for producing knowledge goods narrows the income and welfare gap between the leading and the lagging regions. Third, we find the steady state level of welfare in the leading region. Finally, we note that an increase in the rate at which the lagging region copies the technology for producing knowledge goods may make the leading region worse off