Working Paper: CEPR ID: DP6880
Authors: Ai Ting Goh; Tomasz Michalski
Abstract: The home market effect is considered as a distinguishing feature of models of trade with increasing returns to scale in production and imperfect competition. However, some empirical studies found the existence of home market effect even in constant returns to scale industries. In this paper we build a model of intra-industry trade based upon quality assurance and show the existence of the home market effect without increasing returns in the production technology. This throws into question the rationale of empirical studies attempting to validate the increasing returns model of trade based upon testing the existence of the home market effect.
Keywords: home market effect; intraindustry trade; quality assurance
JEL Codes: F1; R3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| home market effect (R31) | concentration of production in larger market (L11) |
| concentration of production in larger market (L11) | higher demand (R22) |
| higher demand (R22) | enhances reputation for quality (L15) |
| enhances reputation for quality (L15) | satisfies incentive compatibility constraints (D10) |
| home market effect (R31) | empirical findings of home market effect in constant returns to scale (F12) |