June 2024

Demand Uncertainty, Selection, and Trade

Erick Sager and Olga A. Timoshenko


This paper examines the role of uncertainty on elasticities of trade flows with respect to variable trade costs in a canonical model of trade with monopolistic competition and heterogeneous firms. We identify two channels through which uncertainty impacts trade: through export participation thresholds (the selection effect) and the distribution of shocks governing export selection (the dispersion effect). While the selection effect dampens trade elasticities under uncertainty, the dispersion effect is ambiguous. We develop a methodology for using customs firm-level data to quantify trade elasticities under uncertainty, and the magnitude of each of the two channels through which uncertainty impacts trade. We find that uncertainty amplifies trade elasticities, on average, indicating that the dispersion effect of idiosyncratic firm-level shocks dominates -- though the effect is heterogeneous across industries. The overall magnitude of the endogenous selection mechanism on trade elasticities is small, indicating that the main drivers of trade in this class of trade models are overwhelmingly incumbent firms.

Keywords: Demand uncertainty, Extensive margin, Firm size distribution, Selection, Trade elasticities, Welfare

DOI: https://doi.org/10.17016/FEDS.2024.042

PDF: Full Paper

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Last Update: June 14, 2024