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Home Market Effects and the Single-Sector Melitz Model

  • Gabriel J. Felbermayr
  • Benjamin Jung

Increasing-returns-to-scale imperfect competition trade models predict a more than proportionate relationship between the larger country’s share in world endowments and its share in producing firms: the so called home market effect (HME). While this result plays a key role in empirical testing, its theoretical foundation typically posits a linear, friction-free and perfectly competitive outside sector. Replacing this assumption with firm heterogeneity and Melitz (2003) type selection-into-exporting, we demonstrate the existence of a weak and a strong HME. The HMEs are generally non-linear; they are magnified by lower trade costs or more pronounced productivity dispersion. The weak version of the HME continues to hold for general sampling distributions and if the conventional sorting condition fails. In terms of demand shares, a HME holds if demand shocks are due to endowment shocks but reverses in the case of productivity shocks. Finally and in contrast to the model with an outside sector, trade liberalization leads to convergence of real per capita income.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3695.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3695
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  1. Gordon H. Hanson & Chong Xiang, 2002. "The Home Market Effect and Bilateral Trade Patterns," Working Papers 481, Research Seminar in International Economics, University of Michigan.
  2. Davin Chor, 2007. "Subsides for FDI : Implications from a Model with Heterogeneous Firms," Finance Working Papers 22069, East Asian Bureau of Economic Research.
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  14. Svetlana Demidova & Andrés Rodríguez-Clarez, 2011. "The Simple Analytics of the Melitz Model in a Small Open Economy," NBER Working Papers 17521, National Bureau of Economic Research, Inc.
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  16. Toshihiro Okubo & Vincent Rebeyrol, 2006. "Home Market Effect and Regulation Costs - Homogeneous Firm and Heterogeneous Firm Trade Models," IHEID Working Papers 02-2006, Economics Section, The Graduate Institute of International Studies.
  17. Mario LARCH, . "The Home Market Effect in Models with Multinational Enterprises," EcoMod2004 330600089, EcoMod.
  18. Felbermayr, Gabriel & Jung, Benjamin & Larch, Mario, 2013. "Optimal tariffs, retaliation, and the welfare loss from tariff wars in the Melitz model," Munich Reprints in Economics 20591, University of Munich, Department of Economics.
  19. Ottaviano, Gianmarco I.P. & van Ypersele, Tanguy, 2005. "Market size and tax competition," Journal of International Economics, Elsevier, vol. 67(1), pages 25-46, September.
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