The Home market effect with heterogeneous firms

This paper examines the home market effect in the framework of heterogeneous firms. The
paper finds that not only trade costs but also fixed trade costs cause the home market effect and the reverse home market effect can occur as the fixed trade costs are very low. In addition, the agnitude of the home market effect varies with industry characteristics. Industries with low trade costs, high fixed production costs, low fixed export costs, and high productivity dispersion tend to be more concentrated in large countries. Finally, the negative impact of trade barriers on the home market effect is dampened by the elasticity of substitution which is contrary with the result of the homogeneous firm model. An empirical model is built to test these predictions for developed countries. The empirical results are consistent with the predictions of the theoretical model.