This study adapts the workhorse firm heterogeneity model of Melitz and Ottaviano (2008) in two major ways: Each firm can produce multiple products, and factor prices are endogenized so that trade liberalization affects firm choices through both the product market and the factor market. It is found that, after trade liberalization, high efficiency firms may increase product scope, and factor prices may drop.
The study of heterogeneous firms started with single product firms, but attention has recently turned to multiproduct firms. According to Bernard, Jensen and Schott (2005) and Bernard, Redding and Schott (2008), only 41 percent of U.S. manufacturing firms produce more than a single product, but these firms account for 91 percent of U.S. manufacturing output and 95 percent of U.S. exports. Existing researches have taken two approaches in modelling multiproduct firms.
The first is to extend heterogeneity to products within a firm (Bernard, Redding and Schott, 2009; Eckel and Neary, 2010; Mayer, Melitz and Ottaviano, 2009). Trade liberalization bids up the factor price, forcing each firm to drop its marginal products. As a result, all firms reduce scope. The second approach assumes symmetric products within firms. To explain why the market is not taken over by the most efficient firm, Nocke and Yeaple (2006) imposed an exogenous tradeoff between product scope and plant-level productivity. They predicted that high efficiency firms trim product lines after trade liberalization.
We model multiproduct firms differently and reach different conclusions. Like Nocke and Yeaple (2006), we assume within-firm symmetry, but constrain product scope in a different way: Managing varieties within each firm is increasingly costly. Trade liberalization will then lead high efficiency firms to expand their scope and low efficiency firms to shrink the scope.
