Abstract
We study a model of monopolistic competition with firm heterogeneity –in terms of productivity- in which firms provide incentives to managers to reduce marginal cost. In our model managerial incentives are endogenously determined by firm’s productivity and the intensity of competition. We show how tougher competition, generated by large market size or trade, induces stronger incentives to reduce marginal cost for the more-productive firms while the opposite holds for the less-productive firms; this further affects the selection of heterogeneous producers into the domestic and foreign markets. Aggregate productivity growth is decomposed in two sources, within-firm growth and between-firm growth, a decomposition that has not been theoretically analyzed before. We provide a useful theoretical model to analyze how exposure to competition leads to firm productivity growth and how this further affects aggregate performance measures and selection.
Highlights
Over the last decade, a number of studies have examined the relationship between trade openness and productivity finding major improvements in firm productivity as a result of trade liberalization (Amiti and Konings, 2007; Trefler, 2004; Pavcnik, 2002)
We study a model of monopolistic competition with firm heterogeneity –in terms of productivityin which firms provide incentives to managers to reduce marginal cost
We show how tougher competition, generated by large market size or trade, induces stronger incentives to reduce marginal cost for the more-productive firms while the opposite holds for the less-productive firms; this further affects the selection of heterogeneous producers into the domestic and foreign markets
Summary
A number of studies have examined the relationship between trade openness and productivity finding major improvements in firm productivity as a result of trade liberalization (Amiti and Konings, 2007; Trefler, 2004; Pavcnik, 2002). These well documented empirical facts motivated the creation of trade models that incorporated firm heterogeneity to explain industry’s productivity growth as those of Melitz (2003) and Bernard, Eaton, Jensen and Kortum (2003) These models indicate that trade liberalization leads to industry productivity gains due to market share reallocation from the less productive to the most productive firms, what I call the “between-firms” effect. 2. The Model we present a monopolistically competitive model of trade with firm heterogeneity and managerial incentives based on Melitz and Ottaviano (2008). Where and respectively represent the individual consumption levels of the numeraire good and each variety i
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