Distance costs and Multinationals' foreign activities
We derive a gravity equation from two general equilibrium models with multinational firms: a symmetric firm model where foreign affiliates rely on specific intermediate goods and a heterogenous firms model with country-specific fixed costs. Although the reduced form gravity equation is the same, the structural models behind it differ. In the heterogenous firm model less (but larger) firms enter more distant markets which yields lower aggregate sales. In the symmetric firm intermediate input model, in contrast, lower aggregate sales result from lower sales per foreign affiliate. We use the gravity equation to discriminate between the two models. Thereby, we find more support for the heterogenous firm model.
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