Home Market Effect and Regulation Costs - Homogeneous Firm and Heterogeneous Firm Trade Models

This paper studies how market-specific entry sunk costs (regulation costs) affect the Home Market Effect (HME) with firm marginal costs heterogeneity. Our model is based on the Dixit-Stiglitz monopolistic competition model with firm heterogeneity plus regulation costs difference. We find that a regulation costs gap works as dispersion force by inducing a market potential gap, which reduces the HME and could cause the reverse HME or the anti-HME. The Home Market Magnification Effect (HMME) in terms of trade openness is hump-shaped, whereas the pro-HMME in terms of regulation costs coordination by technical barriers to trade (TBT) agreements can be found. Firm heterogeneity dampens the dispersion force by the regulation costs difference and thus works as an agglomeration force. Firm heterogeneity causes a perfect spatial sorting, in which a large country attracts only high productivity firms and vice versa.