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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.

Suggested Citation

  • Potin, Jacques, 2009. "The selection effect of two-way trade in the Melitz model: an alternative approach," ESSEC Working Papers DR 09001, ESSEC Research Center, ESSEC Business School.
  • Handle: RePEc:ebg:essewp:dr-09001
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    1. Francisco Alcalá & Antonio Ciccone, 2004. "Trade and Productivity," The Quarterly Journal of Economics, Oxford University Press, vol. 119(2), pages 613-646.
    2. Andrew B. Bernard & Stephen J. Redding & Peter K. Schott, 2007. "Comparative Advantage and Heterogeneous Firms," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 31-66.
    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. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-959, December.
    5. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-1150, September.
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    Cited by:

    1. Rutzer, Christian, 2014. "A Theory of Trade Liberalization and Innovations with Heterogeneous Firms," Working papers 2014/02, Faculty of Business and Economics - University of Basel.
    2. Rutzer, Christian, 2014. "From the Loser to the Winner - How Trade Liberalization can lead to Leapfrogging between Countries," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100313, Verein für Socialpolitik / German Economic Association.

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    More about this item

    Keywords

    Firm Heterogeneity; Intra-industry Trade; Selection;
    All these keywords.

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation

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