Home market effects and increasing returns with non-constant marginal costs.

The article reexamines the home market effect (HME) in international trade by extending a two-country, multi-industry new trade model to incorporate nonconstant marginal costs and non-homothetic production with heterogeneous factor endowments. It shows that when the fixed cost component of production relies more intensively on factors that are relatively scarcer and more expensive in large countries (e.g., labor), these countries tend to have larger firms and specialize in industries with decreasing marginal costs, reinforcing the HME. Conversely, if fixed costs are intensive in relatively cheaper factors, large countries may have smaller firms and specialize less in such industries despite scale economies. The study finds that fixed costs themselves have limited influence on HME patterns, while the interaction between output elasticity of variable costs and differences in input intensities between fixed and variable costs critically shapes trade specialization and firm size across countries.