5: Heterogenous (Melitz: Gains From Overall Industry Prod Rise Following Trade Liberalisation)

Question 1

So far we assume in trade models firms are symmetric

What do we mean by this

Answer 1

It doesnt matter which precise firms leave and survive the market following trade policy. (Since all homogenous)

In reality firms are heterogenous!

Question 2

Thus firm heterogeneity means winners and losers within same industry!

Answer 2

We’ll see how most efficient producers survive (if c<c*)

Question 3

Stylized facts about exporting (2)

Answer 3

Exporting is extremely rare (Only 18% of US firms export in 2002)

Exporting firms are different

Question 4

Why are exporters different (5)

Answer 4

Larger (double the size of firms that don’t export)
More productive (TFP)
Use factors differently (more skilled and more capital per labour, produce higher quality and innovate)
Pay higher wages
Pollute less

Question 5

Worst performing firms vs best performing firms response to trade

B) as a result what is the effect on overall industry performance

Answer 5

Worst-performing are forced to exit

Best-performing get new sales opportunities from trade and expand the most

B) it improves
Note: trade and economic integration is said to improve overall industry performance as much as discovering a new technology!

Question 6

Firm heterogeneity 2 diagrams pg17

Answer 6

Key thing: heterogeneity means different MCs.

Draw MC2 higher than MC1.

Firm 1 lower MC, sells at a lower price BUT has a higher markup over MC (more profit)

Diagram 2:
y axis operating profit
x axis marginal cost
downward sloping line shows as MC increases, operating profit falls
important: cut off point is c, any firm with c>c shuts down as not profitable

Question 7

Now under economic integration, diagrams pg 20

Answer 7

Diag 1:
Demand curve is now lower intercept and flatter. (More elastic since new firms/market size increases)

Diag 2; steeper and higher intercept to show pore profit can be made for winners, but also which gets a lower cut of point c*’ (where firms will exit). draw on winners losers and exit

Question 8

Imp: Overall does economy gain from trade and why (2)

b) key result from this

Answer 8

Yes
more varieties from higher n
Higher productivity and lower prices (surviving firms have lowest MC)

b) Trade increase industry productivity!

result comes from selection! expels inefficent firms (losers) and most productive lowest MC firms win

Question 9

Free trade does not fully exist, trade costs exist like shipping.

2 types of trade costs (Melitz)

Answer 9

iceberg - in order to sell 1 unit abroad, firms must ship t>1 units

fixed exporting costs e.g regulation costs

Question 10

these trade costs reduce no of firms that sell across borders

what is this known as

Answer 10

extensive margin of trade

Question 11

trade costs also reduce volume of export sales of firms selling abroad

Answer 11

intensive margin of trade

(so extensive margin is amount of firms selling abroad, intensive is the actual volume of exports)

Question 12

so trade costs explain why only some firms export, and the ones that do are larger and more productive (lower MCs) thus can firm these iceberg and fixed costs

Question 13

Add trade costs (t) to the model
Firms response

b) 2 diagrams (home and foreign market)
Pg 24

Answer 13

MC increases, so firms set differnet prices in export market relative to domestic prices

b) diag 1 is just normal MC’s with no trade costs

diag 2: both firms MC (C₁ AND C₂) increase to C₁+t and C₂+t

draw C2+t above the demand curve - whichs they dont choose to export now. So only firm 1 (with the intial lower MC - more productive) exports

Question 14

Operating profit diagam BEFORE LIBERALISATION pg 26

Answer 14

at c* all firms (non-exporting firms also) must exit
at c* - t: can’t export

operating profit for domestic market is higher than operating profit for export market

Question 15

Operating profit after trade liberalisation

b) on the diagram pg 27

Answer 15

trade costs fall so cut off for exporting (c*-t) increase.

however cut of cost for domestic market falls, since liberalisation opens cheaper foreign competition

b) shift down in operating profit for domestic
shift up in operating profit for foreign

Question 16

Imp: so 2 key findings of melitz model

b) key finding - where is gains of trade from

Answer 16

Only productive firms survive (firms with c>c* and c+t>c* must leave), and most productive export (where c+t<c*)

following trade openness, small firms forced to exit (since opens up to foreign cheaper competition)

b) OVERALL industry productivity increases - new source of gains from trade

Question 17

Standard trade theories identify best factor owners e.g HO predicts the owners of the abundant factor benefit the most

Melitz shows winner and loser firms within the same industry! The firm heterogeneity!

Question 18

Pavcnik on link between trade and aggregate productivity

Answer 18

found 2/3s of Chile’s 19% increase in agg productivity was due to survival and growth of high-productivity plants

Supports the idea that gains from trade - being higher agg productivity from trade

Question 19

Criticism as to whether trad liberalisation is really cause of productivity growth

why?

Answer 19

In developing countries, trade liberalisation is used alongside other reforms

so hard to attribute prod growth solely to trade liberalisation

Question 20

So how does Melitz contrast old theories e.g Ricardo

Answer 20

It says gains arise from WITHIN industries (heterogeneity between firms means productive remain which creates gains)

Not BETWEEN industries (like Ricardo, where gains are made by specialising in industries you have a CA in)

Question 21

2 hypothesis on productivity premium seen with exporting firms: why are they more productive

Answer 21

self selection - high producitivity induces firms to export

learning-by-exporting - firms that export learner from foreign markets, causing productivity growth

Question 22

Self selection hypothesis: valid?

Answer 22

Criticism over causal relationship between productivity inducing exporting; data shows exporters can be small, suggesting productivity is not the sole inducer of firms exporting

Question 23

Learning-by-exporting hypothesis

Answer 23

Firms learn from foreign markets - gain better access to tech, techniques, ideas etc.

Question 24

Empirical evidence on selection vs learning hypothesis

(Compare earlier evidence to now)

Answer 24

Earlier evidence showed productivity growth of exporters is not signficantly different from non-exporters (thus dismisses self selection hypothesis)

Now, evidence does support self selection, and more evidence of learning-by-exporting in recent years

Question 25

So importing firms and exports firms have similarities.

Explanation

Answer 25

International production sharing - stages of production are spread across countries.

Explains why productive following trade liberalisation since improves access to cheaper and high quality imported inputs to increase productivity