Market size, structure, and access: Trade with capacity constraints

- A model of international trade with heterogeneous firms facing capacity constraints is developed.
- Capacity constraints soften price competition.
- Trade magnifies the distortions of capacity leading to second best results.
- Thai firm level data link model predictions to firms facing capacity constraints.

This paper develops a model of international trade where firms are heterogeneous across capacity and productivity. A binding capacity constraint induces firms to raise prices in order to take advantage of access to new markets. This generates markets with a flexible competitive structure giving rise to instances where trade and trade liberalization negatively impact welfare. Its key predictions can be identified by observing the presence of small yet highly productive firms and substitution by firms across markets as accessibility evolves. Using Thai firm-level data I establish the prevalence of these anomalous firms and demonstrate they face capacity constraints.