Endogenous Market Structures and International Trade - I: Theory

Abstract

With strategic interactions and endogenous entry in a market, opening up to trade creates gains under very general conditions. Under Dixit-Stiglitz preferences and Cournot (or Bertrand) competition, an expansion of the market size induces exit of domestic firms, lower prices and larger production of the surviving firms due to competition from more foreign firms, without resorting to selection effects a la Melitz. This holds also in a 2x2x2 Heckscher-Ohlin model with Cournot (or Bertrand) competition in a sector. I study heterogenous preferences between countries as a source of trade: the country with a relative preference for the differentiated goods becomes a net importer of them facing radical business destruction. Finally, I extend the model to cost heterogeneity a la Melitz. In all cases, the elasticity of the number of firms to market size decreases with the substitutability between goods and reaches 1/2 under Cournot competition with homogenous goods.