Working Paper No. 10-10
The Home-market Effect across Industries with Heterogeneous Firms
First submitted November 9, 2010, Revised November 24, 2010 as The distribution of firms and countries' size with heterogeneous firms, Revised April 14, 2011
According to Krugman’s home-market effect hypothesis a large country has more firms or products in an increasing returns to scale sector than does a small country. However, the large country’s share of firms (or products) across industries, which are subject to increasing returns to scale, may vary with the characteristics of an industry. This study builds a model of monopolistic competition with heterogeneous firms to investigate several characteristics of an industry that affect the size of the home market effect. Our model predicts that industries with low trade costs, high fixed domestic costs, low fixed export costs, and high productivity dispersion will concentrate more in the large country. Using 3-digit SIC industries from 28 high income countries, the model’s predictions are empirically tested. The empirical results are consistent with the predictions of the theoretical model.
JEL classification: F1, L1
Keywords: Home market effect, countries' size, industry characteristics, heterogeneous firms, distribution of firms, Market Structure