Large and small firms in a global market: David vs. Goliath

This paper studies the impact of trade liberalization when monopolistically competitive and oligopolistic firms coexist in the same market. The model is characterized by a group of multi-product firms which behave strategically and take their impact on market aggregates into account (e.g. the average price, and total output) and by a monopolistically competitive fringe. This difference in behavior leads large firms to charge higher markups. Conditions are derived for the coexistence of both types of firms: heterogeneity in production efficiency, captured by economies of scope for large firms, appears as a necessary condition for them to coexist at equilibrium. Turning to international trade, free trade increases social welfare, as both large and small firms become more competitive. However, when only large firms are able to cover the fixed costs to export, bilateral trade liberalization fosters the exit of small firms, and increases product variety, but it also lowers consumer surplus through a higher average price. Social welfare increases under linear or isoelastic demand but is generally ambiguous.