Market Size, Trade, and Productivity

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…