PUBLICATIONS & REPORTS

Contents Introduction

This research project is designed to examine the effects of demand shock on margins of trade. The 2008-2009 economic crisis hits China's exports severely. However, during this downturn, the extensive margins of exports from China increased. That is, the number of firms participating in the export market rises after the crisis. This observation is in sharp contrast with results found in the existing literature based on the United States market reactions. In order to explain this phenomenon, we extend the Melitz (2003) model by allowing exporting firms to depend on external finance to cover their costs. The model shows that the exporting revenue of each firm (i.e. intensive margin) and the number of exporting firms (i.e. extensive margin) are both negatively affected by the weak foreign demand and benefit from the counter-measures taken by exporting countries, such as quantity easing policy. However, the extensive margin is more sensitive to the change on interest rates than the intensive margin. In other words, the model predicts a decrease in the intensive margin and an increase in the extensive margin at the same time when changes in demand and interest rates fall in a well-behaved interval. Our empirical results from China's firm-level data have provided good evidence for the predictions. This is a joint research project with Bo Chen, Ran Jing and Junjie Hong.