Abstract
This paper develops a general equilibrium trade model with heterogeneous firms and imperfect credit markets. In the model, firms must raise external capital in order to finance the costs for product innovation and for domestic and foreign market entry. The model shows the importance of considering a general equilibrium setting in order to fully characterize the misallocations of resources that derive from the existence of credit frictions. These have important implications for firms entry decisions in the different markets and for the welfare effects of imperfect financial institutions. The paper also shows that allowing for liquidity constrained firms and imperfect credit markets changes, and in some cases reverses, some of main results from the heterogeneous firms literature. In particular the model predicts that trade liberalization does not necessarily lead to an increase of average productivity and consumers’ welfare.