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

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    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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    File URL: http://www.essec.fr/faculty/showDeclFileRes.do?declId=8409&key=__workpaper__
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    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
    Contact details of provider: Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
    Web page: http://www.essec.edu/
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    1. Bernard, Andrew B. & Redding, Stephen J. & Schott, Peter K., 2004. "Comparative Advantage and Heterogenous Firms," CEPR Discussion Papers 4622, C.E.P.R. Discussion Papers.
    2. 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.
    3. 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.
    4. Alcala, Francisco & Ciccone, Antonio, 2001. "Trade and Productivity," CEPR Discussion Papers 3095, C.E.P.R. Discussion Papers.
    5. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
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