DP6880 Quality Assurance and the Home Market Effect
The home market effect is considered as a distinguishing feature of models of trade with increasing returns to scale in production and imperfect competition. However, some empirical studies found the existence of home market effect even in constant returns to scale industries. In this paper we build a model of intra-industry trade based upon quality assurance and show the existence of the home market effect without increasing returns in the production technology. This throws into question the rationale of empirical studies attempting to validate the increasing returns model of trade based upon testing the existence of the home market effect.