Market Access Costs and Trade Dynamics∗

I introduce trade dynamics into a static model of international trade with product dif-ferentiation, heterogeneous productivity firms, and increasing marginal market penetration costs. I interpret firms as ideas that materialize into production, where an idea is a way to produce a differentiated good with a given productivity. Adapting a stochastic process similar to Reed, the model endogenously generates a right tail cross-sectional Pareto distri-bution of firms ’ productivities based on two minimal assumptions: continuous entry of ideas at a certain rate and productivities of ideas that evolve according to a geometric Brownian motion. The cross-sectional predictions of the model for the distribution of domestic and exporting sales of firms are in line with firm-level data. In addition, the model delivers new predictions consistent with panel data observations on domestic and exporting firm-level sales. It predicts that many small firms enter and exit the market very frequently and that the growth rate as well as the variance of the growth rate of sales is higher for small firms. ∗I am grateful to my advisors Timothy Kehoe and Samuel Kortum for their continued guidance and their support. I am also grateful to Cristina Arellano and Jonathan Eaton for continuous encouragement and various discussions on the topic. For their suggestions and comments, I also would to like to thank Erzo G.J. Luttmer