Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Trade Theories with Imperfect Competition and
Increasing Returns to Scale
Giuseppe De Arcangelis
[email protected]
2016 1st Term
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Plan of the lecture
I
Review
I
I
I
I
Equilibrium in monopolistic competition and oligopoly
Increasing returns to scale (IRS)
Preferences and mark-up
Opening up to trade under imperfect competition
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Int’l Trade under Imperfect Competition: Main Effects
1. Pro-competitive effect, i.e. lower prices due to higher
competition from abroad; similar to traditional theories, but it
does not arise from differences among countries
2. Increased-scale effect, i.e. increased production in each
variety that can be sold also in the foreign market and not
only in the domestic market; under increasing returns to scale
(IRS) this means lower average costs, higher profits and
higher welfare
3. Firm-exit effect, i.e. after opening up to trade, there is no
room for all the firms and the total number of firms in the
sector reduces (but it is higher than the number of firms in
each country in autarky).
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Int’l Trade under Imperfect Competition: Main Effects
4 Selection-relocation effect, i.e. the firms that remain in the
market are the most productive ones (the “superstars” gain
market shares); as a consequence, the average productivity of
the economy increases.
5 Increased-variety effect, i.e. consumers can buy a larger
number of varieties from foreign firms; under love-for-variety
preferences this induces a higher welfare.
6 Home-market effect, i.e. biggest countries tend to have a
competitive advantage in IRS sectors, especially when there
are very low barriers to trade (low transportation costs)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Monopoly: set up
I
One single good X
I
Total cost (CRS): c(x) = cx
I
individual demand function: Xi = D(p)
I
m identical consumers;
I
total (market) demand function: X = mD(p); inverse market
X
demand function: p(X ) = D −1 m
I
demand price elasticity: σ > 1 in order to have positive
marginal cost
I
Under monopoly firm’s supply coincides with market supply:
x =X
Giuseppe De Arcangelis
⇒ marginal cost is c.
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Monopoly: equilibrium
I
Profits: Π(X ) = p(X )X − cX
I
Optimal price: pM =
I
Markup over marginal cost is an inverse function of the
demand elasticity; note: if σ → ∞ then pM = c (perfect
competition)
σ
Optimal quantity: X = D(p) = D σ−1
c ; need the shape of
the demand function to obtain the exact quantity
I
σ
σ−1 c
Giuseppe De Arcangelis
h
= 1+
1
σ−1
i
c
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Set up
I
m identical consumers with demand function D(p)
I
n identical firms, each supplies x; total cost: cx
I
n is given, meaning there are barriers to entry
I
Cournot oligopoly: other firms’s are assumed constant and as
given at x
I
Hence, market demand: X = x + (n − 1)x
I
Equilibrium: X = mD(p)
dp(X )
p 0 (X )
dX = m
I
Firm’s profits: Π(X , x) = p(X )x − cx
Giuseppe De Arcangelis
⇒
p(X ) = D −1
New Trade Theories
X
m
. Note:
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Autarky price
FOC of the firm’s profit-maximization problem:
dΠ(X , x)
dp(X )
=
x + p(X ) − c = 0
dx
dx
where
where
dp(X )
dx
dp(X ) dX
dX dx
p 0 (X )
m
since dX
dx = 1. Hence:
p 0 (X ) x
p 0 (X ) X x
c = p(X ) 1 +
= p(X ) 1 +
m p(X )
p(X ) m X
X
n
=
=
= x since firms are all the same, hence
Giuseppe De Arcangelis
New Trade Theories
x
X
= n1 .
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Autarky price
p 0 (X ) X x
p 0 (X ) x
= p(X ) 1 +
c = p(X ) 1 +
m p(X )
p(X ) m X
Moreover, use the demand elasticity:
0
1
dp(X ) X
dp(X ) X
p (X ) X
=−
=−
=−
σ
p(X ) dX
dX p(X )
m p(X )
Hence, the FOC is:
1
nσ
c = p(X ) 1 −
⇒ p(X ) = c
nσ
nσ − 1
where
nσ
nσ−1
is the mark-up.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
International price
Assume two identical countries open up to trade. The total
(world) number of firms in the sector becomes 2n. Hence, the new
world price becomes
2nσ
p(X ) = c
2nσ − 1
Pro-competitive effect: increased competition decreases the world
price.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
International price
I
When the two countries are identical: m = m∗ n = n∗ . In this
case each domestic sector is able to satisfy the domestic
consumption. No international trade, but the discipline effect
of the competition still works.
I
When the domestic country is bigger, m > m∗ , and
m
n
m+m∗ > n+n∗ . Hence the domestic demand of the
oligopolistic good is larger than the domestic production and
the bigger country imports it.
I
When the domestic country is more efficient, n > n∗ , and
m
n
m+m∗ < n+n∗ . Hence the more efficient country exports the
oligopolistic good.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Notes and extensions
Note:
I
In Markusen (1981) we have int’l trade when the two countries
are different in size (m 6= m∗ ) or in efficiency (n 6= n∗ )
I
A similar result can be obtained when making the two markets
different because of the presence of transportation costs
(iceberg type). See Brander and Krugman (1983)
I
In Brander and Krugman (1983) int’l trade arises so as to
break the domestic monopoly and justifies reciprocal dumping.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Effects on the quantities with IRS
Additional assumptions:
I
IRS directly on the total cost function: TC (x) = f + cx where
f are fixed costs.
I
Isoelastic demand function: D(p) = p −σ
nx = mp −σ
⇒ Equilibrium:
Nothing changes in the price determination since the fixed costs do
not affect the marginal principle. Equilibrium quantity:
−σ
m
nσ
x=
c
n
nσ − 1
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Set up
I
Labor is the only input and we measure everything in labor
units (i.e. the wage is equal to 1)
I
m identical workers/consumers with demand function D(p);
they supply inelastically one unit of labor each
I
n identical firms, each supplies x; total cost in labor terms:
l = f + cx
I
Equilibrium in the labor market: m = (f + cx)n
I
Still homogeneous good, but with free entry ⇒ zero-profits
condition in equilibrium to determine the equilibrium number
of firms n
I
Firm’s profits: Π(x) = p(X )x − f − cx
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Autarky
I
Profit maximization induces
h theisame price as in Markusen
nσ
(1981) in autarky: pe = c nσ−1
I
Zero-profit condition determines the per-firm equilibrium
quantity: Π(x) = 0 ⇒ pex − f − cx = 0 ⇒ xe = f (σn−1)
c
I
Substitute the per-firm quantity into the labor-market
equilibrium to obtain the
pnumber of firms:
m = (f + c xe)n ⇒ ne = fmσ
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Opening-up to trade
I
Assume two identical economies with m consumers each and
consider the integrated economy
I
Now the number of firms is endogenous given free entry
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Opening-up to trade
I
I
The total q
number of firms in the integrated economy is given
n, i.e. some firms will exit the market
by: nF = 2m
f σ < 2e
q
e the total number of firms increases;
Since nF = 2m
fσ > n
hence, the free-trade price will be lower and the per-firm
quantity higher (pro-competitive effect)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Opening-up to trade: Conclusion
I
Per-capita consumption: D(p) =
nx
m
=
1
c
q f
1 − σm
.
Hence, it increases in the integrated economy ⇒ all the
consumers are better off
I
Nothing changes from Markusen (1981) in terms of patterns
of trade.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
General set up
I
Differentiated goods: each good x comes in n xi varieties
I
IRS and no cost for differentiating the product and create a
new variety ⇒ each firm produces a different variety ⇒
Monopolistic competition
I
Labor is the only input and we measure everything in labor
units (i.e. the wage is equal to 1)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Other hypotheses
I
n identical firms, each supplies xi i = 1, . . . , n; total cost in
labor terms of each firm: li = f + cxi
I
m identical workers/consumers endowed with one labor unit
each; demand for variety i: di (see later for the derivation of
the demand function from the utility function)
I
Equilibrium
in the
P
P labor market:
m = ni=1 li = ni=1 (f + cxi )
I
Equilibrium in the product market for variety i: mdi = xi
I
Free entry ⇒ zero-profits condition in equilibrium
I
Firm’s profits: Π(xi ) = p(xi )xi − f − cxi same as in monopoly,
but only on the variety xi
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Preferences
I
CES utility function for quantity di of each different variety i:
σ
σ−1 σ−1
Pn
σ
where σ is the elasticity of substitution
U=
i=1 di
among the different varieties
I
Convex indifference curves ⇒ love for variety
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Derivation of the demand function
I
Optimization problem for the consumer:
σ
σ−1 σ−1
Pn
P
σ
s.t. ni=1 pi di = 1
maxdi U =
i=1 di
I
Solution for the optimal di (see pages 165-6 in Basevi, et al.):
di =
p −σ
Pn i 1−σ
i=1 pi
⇒ pi di =
⇒ pi di =
pi 1−σ
P
p 1−σ
Pn i 1−σ
i=1 pi
where
Giuseppe De Arcangelis
P≡
Pn
1−σ
i=1 pi
New Trade Theories
1
1−σ
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Derivation of the demand function
pi 1−σ
P
where
P≡
Pn
1−σ
i=1 pi
1
1−σ
I
pi di =
I
Interpretation: the fraction of income (note: income is equal
to 1 here) spent on variety i depends of the the relative price
of variety i with respect to the general price level P;
differently from homogenous degree 1 utility functions, the
fraction of income spent depends on the relative price.
I
Easy to show that the demand elasticity of variety i to its price
is equal to σ, i.e. the elasticity of substitution among varieties
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Solving the model in autarky
I
σ
Equilibrium price as in the monopoly case: pe = c σ−1
I
Equilibrium quantity of each firm/variety by means of the
zero-profit condition:
Π(xi ) = pexi − f − cxi = 0 ⇒ xei = f (σ−1)
∀i = 1, . . . , n
c
I
Equilibrium in the labor market to
Pndetermine the equilibrium
number
of
firms/varieties:
m
=
i=1 li =
Pn
e
use
x
⇒
m
=
f
σn ⇒ ne = fmσ
(f
+
cx
)
i
i
i=1
I
Equilibrium per-capita consumption di from the variety-i
market equilibrium: mdi = xi use xei ⇒ dei = f (σ−1)
mc
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Some considerations
f (σ−1)
σ
σ
pe = c σ−1
I
Note: differently from the oligopoly case, equilibrium price
and quantity of each (identical) firm does not depend on the
number of firms and a fortiori on the dimension of the market
m; here firms are very small and there is no strategic
interaction among them. Hence, when opening up to trade,
i.e. increasing the market size or m, there is neither
pro-competitive effect nor firm-exit effect. What about
welfare (only utility of consumers)?
xei =
ne =
Giuseppe De Arcangelis
m
fσ
f (σ−1)
mc
I
dei =
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Concluding Remarks: Gains from Trade
I
σ
h
i
σ−1
σ
Pn e σ−1
f (σ−1)
σ
e
σ−1
e
d
=
Autarky welfare: U =
n
=
i
i=1
mc
h
i
h
i
1
σ
σ−1
m σ−1 f (σ−1)
which is increasing in m
= m σ f (σ−1)
fσ
mc
c
(f σ) σ−1
I
In the integrated economy of dimension 2m there’s no effect
on price and quantity in each variety, but consumers are better
off because they can consume more varieties (variety effect)
I
Independently on the dimension there is only intraindustry
trade among the economies and no interindustry trade in
absence of comparative advantages. When transaction costs,
then the dimension counts and the biggest country specializes
in the differentiated (IRS) good.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Hypotheses
Same set up as in Dixit and Norman (1980)
I
Differentiated goods: each good x comes in n xi varieties
I
CES utility function with elasticity of substitution σ
I
IRS and no cost for differentiating the product and create a
new variety ⇒ each firm produces a different variety ⇒
Monopolistic competition
I
Labor is the only input
I
Free entry
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Different set up
I
Two countries H and F with LH and LF workers/consumers
I
ω is the relative wage of F with respect to H (home wage is
the numeraire); hence, national income in H is LH and in F is
ωLF
I
presence of transportation costs
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Transportation costs
I
The quantity τ > 1 leaves the country and arrives as 1 at
destination; i.e. only the quantity 1/τ arrives at destination of
each unit of good that leaves the country
I
The marginal cost of exports is then τ c instead of c
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Effect on prices
I
Prices are now different for the home market and the foreign
market (but this is not pricing-to-market)
pH,H = c
pF ,F = cω
σ
σ−1
σ
σ−1
pH,F = cτ
pF ,H = cωτ
σ
= τ pH,H
σ−1
σ
= τ pF ,F = τ ωpH,H (2)
σ−1
where pI ,J is the price of a variety (they are all the same)
from producer located in country I and sold in market J
Giuseppe De Arcangelis
(1)
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Effect of transport costs on the demand for goods (1)
I
Let us recall the individual demand for goods
p −σ
di = Pn i 1−σ
i=1 pi
I
In the integrated economy with no transportation costs all the
varieties have the same price, independently on the origin;
hence:
p −σ
d=
nH p 1−σ + nF p 1−σ
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Effect of transport costs on the demand for goods (2)
I
In the integrated economy with transport costs we need to
distinguish the different prices of home and imported goods in
the price index in the denominator:
dI ,J =
−σ
pJ,I
1−σ
nI pI1−σ
,I + nJ pJ,I
where dI ,J is the individual demand of the consumer located
in country I for the variety of the firm located in J; for
instance, the following is the demand for the foreign variety
from the home consumer:
pF−σ
,H
dH,F =
1−σ
nH pH,H
+ nF pF1−σ
,H
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Effect of transport costs on the demand for goods (3)
I
Substitute for prices and transport costs:
dH,J =
dF ,J =
−σ
pJ,H
1−σ
nH pH,H
+ nF pF1−σ
,H
−σ
pJ,F
1−σ
nF pF1−σ
,F + nH pH,F
Giuseppe De Arcangelis
−σ
pJ,H
=
1−σ
1−σ
nH pH,H
+ nF (τ ω)1−σ pH,H
=
(3)
−σ
pJ,F
1−σ
1−σ
nF ω 1−σ pH,H
+ nH τ 1−σ pH,H
(4)
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Equilibrium in the markets for varieties
I
Recall the equilibrium condition for a generic variety under
autarky in H and F :
xH = LH dH
I
xF = ωLF dF
In the integrated economy we have two equilibrium conditions
for the typical domestic and foreign variety; for the domestic
variety:
xH = LH dH,H + ωLF τ dF ,H
where we have included the transport costs in the exports.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Equilibrium in the markets for varieties
I
In the integrated economy the equilibrium condition for the
domestic variety:
xH = LH dH,H + ωLF τ dF ,H
I
Let us consider all the domestic varieties altogether by
multiplying by nH pH,H :
nH pH,H xH = nH pH,H dH,H LH + nH pH,H τ dF ,H ωLF
|
{z
} |
{z
}
domestic cons
exports of H
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Balance of payments equilibrium
I
I
Recall goods’ equilibria in both countries:
nH pH,H xH = nH pH,H dH,H LH + nH pH,H τ dF ,H ωLF
{z
} |
{z
}
|
domestic cons
exports of H
(5)
nF pF ,F xF = nF pF ,F dF ,F ωLF + nF pF ,F τ dH,F LH
|
{z
} |
{z
}
domestic cons
imports of H
(6)
Equilibrium in the balance of payments of H:
nH pH,H τ dF ,H ωLF = nF pF ,F τ dH,F LH
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Balance of payments equilibrium: final condition
nH pH,H τ dF ,H ωLF = nF pF ,F τ dH,F LH
I
I
Recall the equilibrium number of firms:
Lk
k = H, F
nk =
σf
(7)
(8)
Substitute eqs (1), (2), (3), (4) and (8) in the bop equilibrium
(7):
1 + τ 1−σ ω 1−σ LLHF
= ω −σ
LF
1−σ + τ 1−σ
LH ω
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Balance of payments equilibrium: final condition
1 + τ 1−σ ω 1−σ LLHF
= ω −σ
LF
1−σ
1−σ
+τ
LH ω
⇒
1 + φλω 1−σ
= ω −σ
λω 1−σ + φ
(9)
where φ ≡ τ 1−σ < 1 and λ ≡ LLHF .
Two cases:
I LF = LH , then ω = 1, i.e. we have FPE
I LF ≷ LH , then it can be shown that ω ≷ 1; i.e. FPE does not
hold and the larger the country, the higher the wage
I In both cases, the proportion of home varieties is equal to the
Lk
relative dimension of the country since nk = σf
k = H, F
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Adding a CRS sector: the home market effect
Let us assume there are two sectors:
I
One IRS sector with a differentiated good (as before)
I
One CRS sector that is traded with no transportation costs
In terms of preferences we assume homothetic preferences in the
choice between the IRS good and the CRS good; hence:
I
µ is the fraction of income spent on the IRS good
I
1 − µ is the fraction of income spent on the CRS good
Free trade for the CRS good ⇒ goods’ price equalization ⇒ FPE,
i.e. ω = 1. Now determine the number of varieties.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Adding a CRS sector: the home market effect
Let us recall goods’ market equilibria (5) and (6) and substitute for
ω = 1 and for equilibrium price and quantities (same as in Dixit
σ
p = c σ−1
and Norman, 1980):e
xei = f (σ−1)
. We obtain:
c
nH f σ =
nF f σ =
1−σ
nH pH,H
1−σ
1−σ
nH pH,H
+ nF (τ )1−σ pH,H
1−σ
nF pH,H
µLH +
µLH +
1−σ
1−σ
nH pH,H
+ nF (τ )1−σ pH,H
1−σ 1−σ
nF pH,H
τ
1−σ
1−σ
nH (τ )1−σ pH,H
+ nF pH,H
1−σ 1−σ
nH pH,H
τ
1−σ
1−σ
nH (τ )1−σ pH,H
+ nF pH,H
1−σ
and set φ ≡ (τ )1−σ .
Let us divide by pH,H
Giuseppe De Arcangelis
New Trade Theories
µLF
µLF
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Adding a CRS sector: the home market effect
nH f σ =
nH
nH φ
µLH +
µLF
nH + nF φ
nH φ + nF
nF
nF φ
µLF +
µLH
nH φ + nF
nH + nF φ
Let us divide member by member and obtain:
nF f σ =
LH
nH
L −φ
= F L
nF
1 − φ LHF
I
since nnHF is positive, then we need φ < LLHF < φ1 , i.e. the two
countries cannot be too different in terms of dimensions.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
The home market effect
LH
nH
L −φ
= F L
nF
1 − φ LHF
Note:
I
when LLHF = 1 then nnHF = 1, i.e. countries of same dimensions
have the same number of firms
I nH
nF
increases more than proportionately than LLHF , i.e. exports
rise more than proportionately w.r.t. income. Domestic
demand rises proportionately (homothetic utility function).
This is the home market effect: larger countries tend to
specialize in the export good.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
The home market effect
LH
nH
L −φ
= F L
nF
1 − φ LHF
Note:
I
The home market effect is stronger, the lower the
n
transportation costs. This is proven by:
∂( nH )
F
L
∂( LH )∂φ
F
pages 178-83 BCO)
Giuseppe De Arcangelis
New Trade Theories
> 0 (see
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Summary
I
Countries with different dimensions; FPE does not hold and
the wage is higher in the biggest country
I
Trade increases with more similar countries (see trade flows in
Krugman, 1980)
I
Home market effect: when considering transaction costs, then
the dimension counts and the biggest country specializes in
the differentiated (IRS) good.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Empirical failures
I
Exporters are only a small fraction of all firms (only 20 per
cent in the US in 1992) and sell a small fraction of output
abroad
I
Exporters are generally bigger (sometimes huge) and more
productive – e.g. Intel, Apple, Toyota, etc.
Definitions:
I
I
I
I
Extensive margin of trade: number of firms that export
Intensive margin of trade: quantity of exports per firms
(approximated by the firm revenue)
Most theories explain int’l trade only with the intensive margin
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Intuition
When firms are different in terms of productivity (or in the
marginal cost), there are new gains from trade:
I Gains from higher efficiency within industry: increased
competition pushes the worst-productive firms out of the
market and average productivity increases.More specifically:
I
I
I
different reaction of heterogeneous firms to increased
competition from abroad in the domestic market, but also
increased market access into the foreign economy;
for winners the positive effect of increased market access
prevails, for losers increased competition prevails
Gains from innovation which increases within-firm efficiency
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
1
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
c
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
2
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
AC
c
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
3
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
AC
c
AR
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
4
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
AC
c
AR
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
5
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
AC
c
AR
MR
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
6
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
AC
c
AR
MR
qaut
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
7
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
paut
AC
c
AR
MR
qaut
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
8
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
paut
AC
c
AR*
AR
MR
qaut
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
9
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
p1
paut
AC
c
AR*
AR
MR
qaut
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
10
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
p1
paut
AC
c
cW
AR*
AR
MR
qaut
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
11
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
p1
paut
AC
c
cW
AR*
AR
MR
MR*
qaut
23/11/2013
Giuseppe
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
12
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
p1
paut
AC
c
cW
AR*
AR
MR
qaut
23/11/2013
Giuseppe
MR*
q*
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
13
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Apertura commerciale con eterogeneità delle imprese
Graph: Int’l trade w/ heterogeneous firms
AC
MC
Price
p0
p1
paut
p*
AC
c
cW
AR*
AR
MR
qaut
23/11/2013
Giuseppe
MR*
q*
Giuseppe
Arcangelis Internazionale
New Trade Theories
De Arcangelis
© DeEconomia
14
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Winners and Losers
I
I
I
I
Let us model different types of firms in terms of marginal cost
Let us consider the effect of opening up to trade on their
profits
Different actions when there are also transport costs
Firm’s residual demand function:
1
x =X
− b(p − P)
(10)
n
where x = firm’s residual demand; X = total industry supply;
n = number of firms; P = average price of the competitors;
p = firm’s price; b = responsiveness of the firm’s demand to
its price.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Gains from Trade when Firms Matter
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Figure 2
99
Performance Differences
across Demand
Firms
Closed economy:
Linear
and Variable Markup
A: Cost, Price
c*
Cost, Price
p2
p1
c2
MC 2
c1
MC 1
MR
q2
D
q1
Quantity
B: Profit
Source: Melitz and Trefler (JEP, 2012)
Operating profit
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Heterogeneous Marginal Costs
I
More productive firms have lower marginal cost
I
More productive firms sell higher quantities at lower prices
I
More productive firms have higher mark-ups (i.e. a measure
of profits as a percentage difference between price and
marginal cost)
I
Note: firms very inefficient such that the marginal cost is
higher than c ∗ cannot stay in the market
I
Why do they enter the market? Because they discover their
abilities only after paying an initial sunk cost
Giuseppe De Arcangelis
New Trade Theories
Cost, Pri
Introduction
c2
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect andc 1increased average productivity
Conclusions
MC 2
MC 1
MR
Closed economy: Profits and Productivity
q2
D
q1
Quantity
B: Profit
Operating profit
Profit
π1o
π2o
c*
c1
c2
c
Net profit
–f
Marginal Cost (MC )
Source: Authors.
Source: Melitz and Trefler (JEP, 2012)
Giuseppe De Arcangelis
c max
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Heterogeneous Profits
I
More productive firms have higher operating profits
I
Net profits are operating profits minus fixed costs
I
Firms can produce as long as operating profits are positive,
although net profits may be negative since operating profits
guaranty the flow profitability
I
When operating profits are negative, the firm must stop
producing and exit the market
I
Equilibrium number of firms when the expected profits to
enter is zero
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Opening up the Economy
I
Increased competition lowers demand to each domestic firms,
i.e. inward shift of the firm demand curve due to the increase
in n in the firm’s demand (10)
I
A larger market size affects the reactivity of demand to firm’s
price, i.e. tilt in the demand curve that becomes more
horizontal due to to the increase in X in the firm’s demand
(10)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
of Economic Perspectives
Krugman 102
(1980):Journal
the home-market
effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Figure 3
Winners
and Losers from Market
Integration
Opening the
economy:
Graph
Price
A: Shift in a firm’s residual curve with international trade
Combined effect of bigger
market size and more competition
D′
More competition
(market size fixed)
D
Quantity
B: Shift in operating profit with international trade
Source: Melitz and Trefler (JEP, 2012)
Operating profit
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Opening up the Economy: Effects of the Different Firms
Different effects depending on the type of firm:
I
the residual demand lowers for the less efficient firms that
operate on the higher part of the demand curve by selling
lower quantities at higher prices (i.e. the negative effect of the
increased competition dominates)
I
the residual demand rises for the more efficient firms that
operate on the lower part of the demand curve by selling
larger quantities at lower prices (i.e. the positive effect of
increased market size dominates)
I
There is now a lower cutoff marginal cost c ∗0 for which the
least efficient firms exit the market
Giuseppe De Arcangelis
New Trade Theories
Price
Combined effect of bigger
market size and more competition
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average
productivity
More competition
Conclusions
(market
size fixed)
D′
D
Opening the economy: Effects on Profits
Quantity
B: Shift in operating profit with international trade
Profit
Operating profit
c*
c *′
Exit
Winners
Losers
Marginal Cost (MC )
Source: Authors.
Source: Melitz and Trefler (JEP, 2012)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Trade Costs and the Choice to Export
I
Transport (or trade) costs increase the marginal cost to serve
the foreign market.
I
It is as if the marginal cost is shifted up when serving the
foreign market.
I
Now the figure above can be used to compare a domestic
more efficient firms with a foreign firms which has a higher
marginal cost due to the trade costs.
I
Operating profits from domestic sales and from exports are
different.
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Marc J. Melitz and Daniel Trefler
105
Figure 4
Export Decision
and Trade on
Liberalization
Effects of Trade
Costs
Profits
A: Operating profits from domestic and export sales
Price
Operating profit (domestic)
Operating profit
(export)
c*
c* – t
c2
c1
Exporters
Nonexporters
c
Exit
Marginal Cost (MC)
B: Effects of trade liberalization on firm decisions
Source: Melitz and Trefler (JEP, 2012)
Operating profit (domestic)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Trade Liberalization: Lower Trade Costs
I
Lower trade costs reduces the overall marginal cost of serving
the foreign market: some efficient firms that could not
marginally export before, now can become exporters
I
These are the winners
I
The same happens for some new efficient foreign firms that
arrive in the domestic market; the higher competition pushes
out of the market some (now) inefficient domestic firms
I
These are the losers
Giuseppe De Arcangelis
New Trade Theories
Price
Introduction
Review
Operatingeffect
profit (OL)
Markusen (1981): the pro-competitive
(export)
Helpman (1984): the firm-exit
effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
*
Krugman (1980): the home-market effect (MC)c – t
c 1 average productivity
Melitz (2003): selection effect and increased
Conclusions
Exporters
c*
c2
c
Nonexporters
Exit
Effects of Trade Liberalization
Marginal Cost (MC)
B: Effects of trade liberalization on firm decisions
Profit
Operating profit (domestic)
Operating
profit (export)
c*
c
New
exporters
New
exit
Marginal Cost (MC)
Source: Authors.
Source: Melitz and Trefler (JEP, 2012)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
Krugman (1980): the home-market effect (MC)
Melitz (2003): selection effect and increased average productivity
Conclusions
Some final considerations
I
There’s no pro-competitive effect since the markup is always
constant with CES preferences. See Melitz and Ottaviano
(2008) for a setup with variable markups due to linear demand
function (as in Krugman, 1979)
I
This same setup can be used to explain the firms’
internationalization via foreign direct investment: once again,
the most efficient firms are also the ones that will become
multinationals (as observed at the beginning)
Giuseppe De Arcangelis
New Trade Theories
Introduction
Review
Markusen (1981): the pro-competitive effect (OL)
Helpman (1984): the firm-exit effect (OL)
Dixit and Norman (1980): the increased-variety effect (MC)
sep06_Article1
PM Page 598 effect (MC)
Krugman 8/8/06
(1980):10:00
the home-market
Melitz (2003): selection effect and increased average productivity
Conclusions
Who does
FDI?
598
Journal of Economic Literature, Vol. XLIV (September 2006)
S
0
SD
4D
4 "X
S I"
S X"
4 "I
4
cf D
cf X
cf I
Figure 3. Multinationals, Exporting, and Nonexporting Firms
Source: Helpman (JEL, 2006)
technology H or a traditional technology L, as
in Yeaple (2005). The advanced technology
requires higher fixedGiuseppe
costs, soDe
that
fDH > fDL
Arcangelis
Argentinian firms. This raises the operating
profits of all exporters, but proportionately
more
from Theories
the use of the advanced techNewsoTrade