Assessing gains of trade in monopolistic competition under the presence of industry leaders

Abstract

ABSTRACT A recent literature has documented a widespread rise of superstar firms. This is at odds with the simplifying assumption of a continuum of firms, predominant in International Trade. In this paper, we assess its consequences by identifying the magnitude and direction in which gains of trade depart from monopolistic competition once we account for leading firms. With this goal, we extend the Melitz model by incorporating a revenue threshold such that truly negligible firms are modelled as in Melitz, while the largest ones are treated as non-negligible firms that earn positive profits. Firm-level data for several countries show that accounting for leaders entails greater gains of trade in all cases, with differences of up to 20%. The outcome is explained by an additional benefit of reallocating resources towards more productive firms, not captured by the Melitz model: increases in aggregate income through positive effects on profits.