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Market size and TFP in the Melitz model

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  • Felbermayr, Gabriel
  • Jung, Benjamin

Abstract

Trade theory in the Krugman tradition predicts a positive correlation between market size and countries' total factor productivity (TFP). However, in the data, there is no such correlation. Models with heterogeneous firms and selection can reconcile theory and empirics, when the degree of external economies of scale is lower than assumed in the standard CES case. Realistically, larger countries have an over‐proportionate share of firms. With export selection, these countries have more input varieties available, but they also have a lower average productivity of firms. Which of these effects dominates depends on the degree of external economies of scale.

Suggested Citation

  • Felbermayr, Gabriel & Jung, Benjamin, 2018. "Market size and TFP in the Melitz model," Munich Reprints in Economics 58908, University of Munich, Department of Economics.
  • Handle: RePEc:lmu:muenar:58908
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