Market Size, Trade, and Productivity Melitz and Ottaviano. Felix Bausch

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1 Market Size, Trade, and Produtivity Meitz and Ottaviano Feix Baush

2 Overview 1. Genera features of the mode 2. The osed eonomy 3. The open eonomy two ountries 4. Trade iberaization shemes 5. The open eonomy three ountries 6. Summary 2

3 Genera features of the mode Monopoisti ompetition Heterogeneous firms Cost draws Utiity funtion U q q di ( q )² di i 2 i 2 i i i i 2 α and η measure the substitution between differentiated varieties, q i, and the numeraire, q 0 γ measures the degree of substitutabiity between differentiated goods. q di 3

4 Genera features of the mode Properties of the demand system: Love for variety Variane of pries inreases wefare In ontrast to CES demand, prie eastiity of demand is not soey determined by γ Lower average pries and higher number of firms indue tougher ompetition environment 4

5 The osed eonomy Prodution and firm behaviour L ony fator of prodution Numeraire good produed under CRS at unit ost -> unit wage Entry ost f E 0 is needed to earn about produtivity represented by margina ost If ost is ower than ost utoff, the firm wi produe Lower ost impies ower pries and higher revenues, profits, mark-ups and quantities Expeted firm profits must satisfy: D 0 dg f 0 E 5

6 The osed eonomy Prodution and firm behavior (td.) Average produtivity rises in market size and deines in entry osts and γ Parameterization of tehnoogy A resuts up to now are independent of G() In the foowing: Pareto distribution used Market size effet: positive for wefare Lower average markups outweigh higher reative markups Average industry profitabiity stays unaffeted Varianes of ost, pries and markups are ower in bigger markets Variane of firm size inreases with market size 6

7 The open eonomy two ountries 7 In prinipe an open eonomy framework without any trade barriers woud orrespond to an inrease in market size inuding the hanges in parameters disussed before Introdue ieberg transport osts τ No fixed trade osts Countries differ in market size and trade ost ony Firms maximize profits for domesti and export markets independent of eah other ) ( ] ) ( [ ) ( ) ( ] ) ( [ ) ( q p q p X h X X D D D

8 The open eonomy two ountries The ost ut-offs for firms are determined as in the osed eonomy mode with: h X D Competition is harder in export markets than in domesti markets. Therefore ut-offs are ower Given same tehnoogy (fixed ost and parametrization), free entry ondition beomes: D X ( ) dg( ) ( ) dg( ) D X 0 0 f E 8

9 The open eonomy two ountries Pries, produt variety and wefare As the whoe setup is symmetri unti now, wefare hanges monotoniay with the domesti ut-off Export patterns Ony those firms whih are most profitabe export Ony firms who serve the domesti market aso export Due to p D ( ) px ( ) h reiproa dumping ours and impies a no arbitrage ondition 9

10 The open eonomy two ountries The impat of trade A firm eve variabes orrespond to the osed eonomy equiibrium with a given ost ut-off Open eonomy impies ower ut-off Meitz 2003 Meitz & Ottaviano 2008 Inreased ompetition for sare abor, driving ess produtive firms out of the market via higher wages paid by exporting firms Suppy of abor is perfety easti. Ony more ompetition on produt markets due to imported varieties Fator market ompetition Produt market ompetition 10

11 The open eonomy two ountries The impat of trade (td.) Gains from trade: Produtivity gains (seetion) Lower mark-ups (pro-ompetitive effets) Inreased produt variety Market size effets No ompete integration of markets due to trade osts Size effets remain (but not in magnitude) Bigger markets are (partiay) offset by fierer ompetition 11

12 Trade iberaization shemes Symmetri iberaization Equivaent to transition from autarky to open eonomy Number of varieties inreases, pries and mark-ups (absoute) go down Wefare inreases Long-run onsequenes for the distribution of firms among both ountries in favor of the bigger market 12

13 Trade iberaization shemes Uniatera iberaization Dereasing number of firms in the iberaizing ountry Wefare osses in the iberaizing ountry due to entry ondition in the ong-run Short-run effets differ: Higher ompetition and variety in iberaizing ountry No hanges in the other ountry Wefare gains in iberaizing ountry 13

14 Trade iberaization shemes Preferentia iberaization Introduing a third ountry in the mode With symmetri trade osts, no new insights to the twoountry ase Coud aso be extended to n-ountry mode Assumption: 3 ountries of equa size 14

15 The Open Eonomy three ountries Trade patterns Cut-off is owest in ountry with owest sum of biatera barriers -> best export base Those ountries who are iberaizing, benefit from ower ut-offs Wefare gains in iberaizing ountries Wefare oss for the exuded ountry 15

16 Summary Expanded Meitz (2003) Mode Fous on produt market ompetition Trade iberaization shemes an be expained Possibiity to expand the mode to mutipe ountry senarios Fous on firm eve measures 16

17 Thank you for your attention 17

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