DP2938 The Importance of Being Small. Or When Countries are Areas and not Points

Author(s): Joe Tharakan, Jacques-Fran├žois Thisse
Publication Date: September 2001
Keyword(s): geographical nation size, international Trade, mill pricing, spatial competition
JEL(s): F12, L13
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2938

Market size and transport costs are important ingredients of international trade. We propose to look at these issues from a different perspective. Using a Hotelling duopoly model with quadratic transport costs, we analyse the welfare effects of international trade between two countries that differ only in size. Our results indicate that in most cases free trade will lead to a decrease in prices. Furthermore, the firm of the small country will benefit from market expansion. Finally, the model predicts that the small country benefits from a move towards free trade whereas the opening to trade may hurt the large country.