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The selection effect of two-way trade in the Melitz model: an alternative approach

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  • Potin, Jacques

    ()
    (ESSEC Business School)

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    Abstract

    This paper studies the influential Melitz model of trade with heterogeneous firms using an alternative, intuitive approach. Contrary to what is often argued, it is an increase in product market competition that drives the bad firms out: with two-way trade, entry by foreign firms is not compensated by a “sufficient” reduction in the mass of surviving firms. To illustrate this, we decompose the total effect of trade in two partial effects: a domestic-profit-reducing effect due to foreign market penetration by the most productive firms; an average-profit-reducing effect due to the payment of the fixed export costs. We also provide the new prediction that trade generally leads to (weakly) less entry in the industry. This clarifies key interpretation issues in a prolific literature.

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    Bibliographic Info

    Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number DR 09001.

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    Length: 16 pages
    Date of creation: Apr 2009
    Date of revision:
    Handle: RePEc:ebg:essewp:dr-09001

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    Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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    Related research

    Keywords: Firm Heterogeneity; Intra-industry Trade; Selection;

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    1. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    2. Andrew Bernard & Stephen Redding & Peter Schott, 2004. "Comparative advantage and heterogeneous firms," IFS Working Papers W04/24, Institute for Fiscal Studies.
    3. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
    4. Francisco Alcalá & Antonio Ciccone, 2004. "Trade and Productivity," The Quarterly Journal of Economics, MIT Press, vol. 119(2), pages 612-645, May.
    5. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
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