Trade Flow Dynamics with Heterogeneous Firms

Recent work, both theoretical and empirical, has highlighted a fundamental property of international trade patterns. When trade flows vary, either across countries or within a country over time, so does the number of goods embodied in those trade flows (as well as the number of firms engaging in those international transactions). This recent work has further shown that this extensive margin of trade is not an inconsequential property of trade flows that can safely be ignored. Rather, it plays a crucial role in explaining several important international economic phenomena. Patrick J. Kehoe and Kim J. Ruhl (2002) show how large responses of trade flows to small but long-lasting reductions in trade costs (driven by trade liberalization) are driven by a substantial response in the extensive margin of trade (export of new goods). Ruhl (2003) theoretically shows how such differences in the extensive margin of trade responses, between transitory business cycle and long lasting trade liberalization shocks, can explain the very large differences observed in the elasticity of trade response at high versus low frequencies. Elhanan Helpman, Melitz, and Yona Rubinstein (2006) show how the incorporation of the extensive margin of trade can substantially improve the fit and predictive power of the standard bilateral trade gravity specifications. Thomas Chaney (2006) shows theoretically and empirically how the extensive margin of trade reverses the (previously assumed) amplification effect of product substitutability on trade costs. Christian Broda and David E. Weinstein (2006a) and