Disproportionate Gains: A Home Market Effect in an Almost Arbitrary Geography

Abstract

The Home Market Effect (HME) provides a mechanism for trade driven by demand: locations with a comparatively large consumer base for an industry specializes in production of that industry. The theory originates with Krugman in the 1980s, yet, despite the many iterations since, sharp theoretical predictions are only given in two-location models. As the world has more than two locations, empirical operationalization requires, therefore, assumptions outside of the model. By making only a single additional assumption relative to the canon --- the matrix of interregional iceberg trade costs is positive semi-definite --- I prove that the HME continues to hold in many location models on average. Furthermore, the empiricist needs to make little amendment: the HME hypothesis test valid in many-locations is almost identical to that already being implemented using the two-location hypothesis.