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Home Market Effects and the Single-Sector Melitz Model

49 Pages Posted: 11 Jan 2012  

Gabriel J. Felbermayr

University of Stuttgart-Hohenheim

Benjamin Jung

University of Hohenheim

Date Written: December 30, 2011


Increasing-returns-to-scale imperfect competition trade models predict a more than proportionate relationship between the larger country’s share in world endowments and its share in producing firms: the so called home market effect (HME). While this result plays a key role in empirical testing, its theoretical foundation typically posits a linear, friction-free and perfectly competitive outside sector. Replacing this assumption with firm heterogeneity and Melitz (2003) type selection-into-exporting, we demonstrate the existence of a weak and a strong HME. The HMEs are generally non-linear; they are magnified by lower trade costs or more pronounced productivity dispersion. The weak version of the HME continues to hold for general sampling distributions and if the conventional sorting condition fails. In terms of demand shares, a HME holds if demand shocks are due to endowment shocks but reverses in the case of productivity shocks. Finally and in contrast to the model with an outside sector, trade liberalization leads to convergence of real per capita income.

Keywords: home market effect, monopolistic competition, heterogeneous firms, economic geography

JEL Classification: F120, R120

Suggested Citation

Felbermayr, Gabriel J. and Jung, Benjamin, Home Market Effects and the Single-Sector Melitz Model (December 30, 2011). CESifo Working Paper Series No. 3695. Available at SSRN:

Gabriel J. Felbermayr (Contact Author)

University of Stuttgart-Hohenheim ( email )

Keplerstraße 17
D-70174 Stuttgart

Benjamin Jung

University of Hohenheim ( email )

Schloss-Mittelhof (Ost)
70593 Stuttgart

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