Department of Economics, UCSD

This paper develops a New Trade Theory model modified with entry barriers, thereby creating a link between the traditional interests of development and industrial organization economists and research on international trade. I show that entry barriers cause the market size to become endogenous by creating rents. Furthermore, I prove that the endogeneity of market size has four implications. First, governments can use trade policy to shift foreign rents to their countries and enlarge their home markets. Second, endogenous market size magnifies the standard home-market effect. Third, the endogeneity of market size interferes with the unambiguous Pareto optimality of trade agreements. In particular, if rents are suffciently large and the country size is suffciently small, a trade agreement will negatively affect the country in question. Therefore, I consider a new research question: what are consequences of trade agreements in terms of welfare redistribution? Finally, I show that an increase in entry barriers increases the market size of large countries. If the market size increase is suffciently large, the country benefits. These results challenge the idea that higher entry barriers decrease welfare.