Intra-Industry Trade between Asymmetric Countries with Heterogeneous Firms
University of Nottingham Research Paper No. 2004/05
33 Pages Posted: 28 Feb 2005
Date Written: 2004
Abstract
This paper constructs a two-country intra-industry trade model with efficiency differences at both national and firm level, to focus on the impact of trade on asymmetric countries. We show that in both countries opening up to trade strengthens the self-selection effect, raises average industry revenue, profit and efficiency and generates welfare gains. However, cross-country efficiency gaps lead to substantial differences in the magnitude of these trade-induced changes. The more efficient country has a greater proportion of exporting firms and a higher failure rate, which makes entry more risky. However, for successful entrants expected revenue is higher and entry is therefore also more profitable. Since the rationalisation effect is also stronger in the more efficient country, welfare gains from trade are higher.
Keywords: firm heterogeneity, cross-country efficiency gaps, intra-industry trade
JEL Classification: F12, L11
Suggested Citation: Suggested Citation
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