Investments in Productivity and Quality under Trade Liberalization: Monopolistic Competition Model

We study impact of trade liberalization on firms productivity and product quality in a monopolistic competition model. Utility has variable elasticity of substitution ($VES$), a producer can invest in decreasing marginal cost or in increasing quality and free entry drives profits to zero. Then in a closed economy such investments increase with the market size if and only if utility shows increasing “relative love for variety” which is elasticity of the inverse demand. Expanding these findings to international trade setting, we expect to find comparative statics of equilibria with respect to the market size and trade costs.