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    The author is very grateful to the editor, Mark Partridge, and Masahisa Fujita, Yasusada Murata, Gianmarco Ottaviano, Diego Puga, as well as other participants in the 53rd Annual North American Meetings of the Regional Science Association International, Toronto 2006, and two anonymous referees for very helpful comments. The usual disclaimer applies.


ABSTRACT We investigate the effect of preference heterogeneity between skilled and unskilled workers on agglomeration, and we identify a new source of dependence of equilibrium prices on the demand properties shaped by the inter-regional distribution of workers. We find a new preference effect, and we show that when the intensity of skilled workers' preference for the modern good and its variety is strong enough, prices charged by firms may even increase when the mass of local firms increases, therefore acting as a new dispersion force when trade costs are low or as a new agglomeration force when trade costs are high.