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Competitive effects of trade: theory and measurement

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Abstract

In this paper, I develop a simple model of heterogeneous exporters to a single destination. This model highlights how the response of producer markups to market-level changes in that destination are intrinsically tied to the induced reallocation of export sales to that destination. I discuss how additional assumptions on the shape of demand (originally advocated by Alfred Marshall as his second law of demand) generate specific predictions for the response of those markups and induced product reallocations to increases in market size and competition in a destination: markups fall and market shares are reallocated towards better performing products. Recent evidence on French multi-product exporters strongly confirms this prediction for market share reallocations. The predictions for the markup responses are also consistent with the findings of the large empirical literature on pricing to market and incomplete pass-through.

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Fig. 1
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Notes

  1. See the evidence reviewed in De Loecker and Goldberg (2014), Burstein and Gopinath (2014), and Yilmazkuday (2015).

  2. See Berman et al. (2012) for France, Amiti et al. (2014) for Belgium, Chatterjee et al. (2013) for Brazil, and Li et al. (2015) for China.

  3. See Melitz and Redding (2014) for a survey.

  4. There is an active literature analyzing the properties of monopolistic competition with endogenous markups generated by variable elasticities of substitution on the demand side. See, for example, Zhelobodko et al. (2012), Bertoletti and Epifani (2014), and Mrázová and Neary (2013).

  5. In the case of C.E.S. preferences, the marginal utility of income \(\lambda\) is an inverse monotone function of the C.E.S. price index.

  6. This can be shown by contradiction: Assume that competition \(\lambda\) were to decrease following an increase in market size L. Then, from (4), the export cutoff \(\hat{c}\) must increase. This would then violate the budget constraint (5) as spending must then rise [higher cutoff \(\hat{c}\) and higher sales \(r(c,\lambda )\) for all firms due to decrease in competition \(\lambda\)].

  7. Consider a similar proof by contradiction: assume that competition \(\lambda\) were to decrease following a increase in N. Then, from (4), the export cutoff \(\hat{c}\) must increase, which would then violate the budget constraint (5) as spending must then rise.

  8. Recall that firm output per consumer \(q(c,\lambda )\) is decreasing in competition \(\lambda\).

  9. Marshall’s First Law of Demand is that it is downward sloping; this too can be violated with rational utility maximizing consumers.

  10. Several other terms have been used to describe MSLD demand in the literature on monopolistic competition with endogenous markups. Zhelobodko et al. (2012) describe those preferences as exhibiting increasing “relative love of variety” (RLV); Mrázová and Neary (2013) describe this as the case of “sub-convex” demand; and Bertoletti and Epifani (2014) use the term “decreasing elasticity of substitution”.

  11. This property of incomplete pass-through also applies to exchange rate changes. In this case however, the change in delivered cost impacts the entire set of firms with a common currency selling into a given destination. This induces a change in competition \(\lambda\) which amplifies the price response. Nevertheless, the pass-through rate remains incomplete.

  12. It is the key characteristic of the demand systems analyzed by Spearot (2013), Novy (2013), and Arkolakis et al. (2015) in order to explain the empirical variations in the trade elasticity (at the intensive product margin).

  13. \(u(q_{i})\) quadratic, leading to linear demand \(p(q_{i})\) is a simple functional form satisfying MSLD’ (and hence MSLD).

  14. Take two firms with costs \(c_{1}\) and \(c_{2}\) in the graph. The proportional change for any performance measure from the increase in competition \(\lambda\) is indexed by the difference in the vertical intercept for these two firms. This difference must increase as the curve with tougher competition \(\lambda '>\lambda\) is steeper everywhere.

  15. See the cutoff equation (4).

  16. Aghion et al. (2017) show that this divergence has important consequences for the firms’ innovation response to demand shocks in their export markets; consequences with strong empirical support: better performing firms respond to a positive demand shock by increasing innovation, whereas worse performers respond to the same shock by decreasing innovation.

  17. See De Loecker and Goldberg (2014) for a discussion of these data and functional form requirements.

  18. See Dhingra and Morrow (2018) for a normative analysis of monopolistic competition with endogenous markups.

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Acknowledgements

Based on the Bernhard Harms Prize Lecture delivered at the Kiel Institute of World Economics on December 7, 2016. I thank and acknowledge my co-authors Thierry Mayer and Gianmarco Ottaviano with whom I have collaborated to produce the research described in this lecture.

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Melitz, M.J. Competitive effects of trade: theory and measurement. Rev World Econ 154, 1–13 (2018). https://doi.org/10.1007/s10290-017-0303-3

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