Market Size, Trade, and Productivity

TLDR

The study develops a monopolistically competitive trade model incorporating firm heterogeneity and endogenous market competition toughness, and examines how market size and trade liberalization affect these features across imperfectly integrated markets. The model links market size and trade to competition toughness, which in turn determines the selection of heterogeneous producers and exporters, and remains tractable even when extended to multiple asymmetric countries with varying trade costs. The results show that larger, more integrated markets exhibit higher aggregate productivity and lower markups, and the framework is useful for analyzing trade and regional integration policy scenarios with heterogeneous firms and endogenous markups.

Abstract

We develop a monopolistically competitive model of trade with firm heterogeneity - in terms of productivity differences - and endogenous differences in the 'toughness' of competition across markets - in terms of the number and average productivity of competing firms. We analyze how these features vary across markets of different size that are not perfectly integrated through trade; we then study the effects of different trade liberalization policies. In our model, market size and trade affect the toughness of competition, which then feeds back into the selection of heterogeneous producers and exporters in that market. Aggregate productivity and average markups thus respond to both the size of a market and the extent of its integration through trade (larger, more integrated markets exhibit higher productivity and lower markups). Our model remains highly tractable, even when extended to a general framework with multiple asymmetric countries integrated to different extents through asymmetric trade costs. We believe this provides a useful modeling framework that is particularly well suited to the analysis of trade and regional integration policy scenarios in an environment with heterogeneous firms and endogenous markups.