Tuesday 13 September 2016

Home-Market Effect Tested

The home-market effect is a theory that is part of the so-called New Trade Theory and which states that because of increasing returns to scale and trade costs countries are likely to exports those goods which are consumed most in their markets, or in other words, for which they have relatively large domestic markets. 

The increasing returns to scale will make it that firms are willing to locate in one market whilst trade costs will trigger firms to locate in larger markets. Hence, there is a link between market size (i.e. demand) and exports, not necessarily only imports as classical trade theory would predict. A sophisticated test of the home-market effect is now available in a new NBER paper from Costinot, Donaldson, Kyle and Williams. 

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