Thomas Chaney, and Ralph Ossa, “Market Size, Division of Labor, and Firm Productivity”, July 2012.
We generalize Krugman's (1979) "new trade"model by allowing for an explicit production chain in which a range of tasks is performed sequentially by a number of specialized teams. We demonstrate that an increase in market size induces a deeper division of labor among these teams which leads to an increase in fim productivity. The paper can be thought of as a formalization of Smith's (1776) famous theorem that the division of labor is limited by the extent of the market. It also sheds light on how market size di¤erences can limit the scope for international technology transfers.