A Model of Trade with Endogenous Product Design

We study a model of international trade in which firms choose between a board product design that targets mainstream consumers, and a niche product design that targets specific market segments. Assuming that local firms have absolute advantage in providing niche products to the local market, we show that in equilibrium, the more efficient firms adopt a board design and export whereas the less efficient firms adopt a niche design and do not export. A reduction in trade cost encourages efficient firms to adopt a board design and export, whereas it encourages inefficient firms to adopt a niche design. Consequently, trade liberalization changes the composition of product designs available in the market, which in turn affects consumers' welfare. Our analysis illustrates a novel possibility that certain stage of trade liberalization could have a negative impact on welfare if it leads to an increase in the proportion of firms adopting board designs that provide a low consumer surplus. A negative pro-competitive effect may arise when more firms are choosing niche designs after trade liberalization.