Trade with Search Frictions: Identifying New Gains from Trade

This paper develops a dynamic industry model to study the effect of search frictions on industry structure and aggregate welfare. We consider a search-theoretic setting with two types of agents, firms and suppliers. To customize inputs, each firm needs to find a supplier but search is costly and does not always end in success. Matched firms use customized inputs obtained from matched suppliers to enhance production efficiency, while unmatched firms use generic inputs obtained from a competitive input market. In equilibrium the number of unmatched and matched firms is endogenous. We use this model to contrast the implications of two forms of economic integration: integration of final-good markets allowing firms to export varieties to another market, and integration of matching markets allowing firms to seek suppliers from another market. We show that the former form of integration can amplify the welfare gains from trade by improving firms’ matching frequency associated with resource reallocations from unmatched firms to matched firms. In contrast, the latter might cause welfare losses by hindering the resource-reallocation process of firms.