Location, Productivity, and Trade

Does trade liberalization increase competition? Location models provide a natural tool for answering this question, but, because of technical problems, their use in the trade literature has been limited. This paper develops a novel location model which is robust to arbitrary differences in productivity. In an otherwise standard general equilibrium trade environment, the model remains tractable under consumer preferences which are dramatically more general than those in traditional location models. I find that firms set variable markups which are increasing in firm productivity but which decline under a trade reform. Variable markups offer several improvements over the standard Dixit-Stiglitz framework with CES preferences, including the presence of small firms and measured gains in GDP under a trade reform. In this model trade liberalization reduces the total number of firms and increases their isolation in product space in a range of parameters that best explains firm data.