NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

International Trade: Linking Micro and Macro

Jonathan Eaton, Samuel S. Kortum, Sebastian Sotelo

NBER Working Paper No. 17864
Issued in February 2012
NBER Program(s):   ITI   PR

A recent literature has introduced heterogeneous firms into models of international trade. This literature has adopted the convention of treating individual firms as points on a continuum. While the continuum offers many advantages this convenience comes at some cost: (1) Shocks to individual firms can never have an aggregate effect. (2) It is hard to reconcile the small (sometimes zero) number of firms engaged in selling from one country to another with a continuum. (3) For such models to deliver finite solutions for aggregates, such as the price index, requires restrictions on parameter values that may not hold in the data. We show how a standard heterogeneous-firm trade model can be amended to allow for only an integer number of firms. The model overcomes the deficiencies of the continuum model enumerated above. Taking the model to aggregate data on bilateral trade in manufactures among 92 countries and to firm-level export data for a much narrower sample shows that it accounts for both the large share of a small number of firms in sales around the world and for zeros in bilateral trade data while maintaining the good fit of the standard gravity equation among country pairs with thick trade volumes. Randomness at the firm level adds substantially to aggregate variability.

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Document Object Identifier (DOI): 10.3386/w17864

\International Trade: Linking Micro and Macro," (with Jonathan Eaton and Sebastian Sotelo) forthcoming in Daron Acemoglu, Manuel Arellano, and Eddie Dekel, eds., Advances in Economics and Econometrics: Theory and Applications, Tenth World Congress, Volumes I, II, and III.

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