This paper presents the relationship between market openness and markup distribution of firms. Theoretical predictions by the recent literature on firm heterogeneity and international trade by Melitz and Ottaviano (2007) are described and build up the infrastructure of the work. Melitz and Ottaviano offer a framework that can accommodate multiple, heterogeneous countries in intra and inter industry trade. Moreover, it allows variable markups, lower markups with tougher competition meanwhile higher markups are charged by firms that are more productive. At the firm-level, the Melitz and Ottaviano predict that: 1) markups are negatively linked to market size; 2) markups and firm productivity are positively related.
This seminar paper on the topic of "Firm-level Heterogeneity and markups", aims to analyze heterogeneous firms' behavior in the international trade. "Heterogeneity of firms in productivity creates gains from trade so that the more productive firms gain market share at the expense of the less productive ones raising the average productivity in the economy". (Bekkers 2008, p.16).
Two factors can contribute to the reallocation effect of trade in the new trade theory: enhanced labor market competition or enhanced product market competition. Since 2003 that Melitz significant paper on firms' decision to export was published, there have been several other literatures on the topic with heterogeneous firms' behavior.
The paper presented here is based on the paper introduced by Melitz and Ottaviano (2007) that particularly links productivity, prices and markups to the number of competing firms. It predicts the effects of openness to trade on the market structure and explains on the firm-level performance levels. Ottaviano, Tabuchi and Thisse (2002) model the monopolistically competitive markets differently, they develop a linear demand system with horizontal product differentiation where the price elasticity of residual demand is not fixed anymore but it is increasing in the number of competitors. The preferences are not CES. The MO model takes this demand system and builds the model on it. Relaxing the CES assumption in MO model is a distinction to Melitz work before. The performance measures are: price, productivity, market size and mark-ups. Pricing behavior depends on the number of competitors and the average price level in contrast to standard CES-preferences where prices are .fixed mark-ups over marginal cost. (Bekkers 2008, p25) A monopolistic competition model is to set where firms maximize profits based on their linear residual demand curve, taking N and p as given, and there is free entry into the industry. The closed-economy version and then the open-economy with a two-country case are presented followed by predictions for the effects of trade liberalizations on trade considering a bilateral and unilateral liberalization. An overview of similar models is given with a try to explain and motivate why this model is important(责任编辑：BUG)