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  5. Combinatorial Discrete Choice: Theory and Application to Multinational Production

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Combinatorial Discrete Choice: Theory and Application to Multinational Production

  • Costas Arkolakis
  • Fabian Eckert
  • Rowan Shi
American Economic Review (Forthcoming)

Abstract

In general, finding the optimal combination among N items requires evaluating all 2^N possibilities. We develop a method applicable whenever items are complements or substitutes that uses this structure to discard suboptimal combinations without evaluation and extends to heterogeneous-agent environments. In a calibrated general equilibrium model of multinational firms choosing interdependent production locations, we show the method is orders of magnitude faster than incumbent approaches and avoids error from discretizing firm heterogeneity. Quantitatively, whether production locations are complements or substitutes determines whether welfare gains from multinational production concentrate in the most productive countries or accrue more broadly.

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