chapter  16
12 Pages

Increasing costs in product diversification

The observation of two-way trade in similar goods among advanced countries has led to the construction of theoretical models based on increasing returns to scale, product differentiation, and imperfect competition. In particular, trade models under monopolistic competition have been investigated intensively.2 In previous studies of monopolistically competitive trade models, it has been assumed that every firm has the same level of fixed costs. Spence (1976) pointed out that differences in fixed costs played the crucial role in determining market equilibrium. However, little attention has been given to the role of differences in fixed costs in monopolistically competitive trade models. In one-factor trade models with symmetric cost functions, there have been some ambiguities about the process of entry and exit (which firm enters the market and which one exits) and the direction of trade (which country produces which goods).3