This paper introduces firm heterogeneity into a simple model of international trade, focusing on the intensive and extensive margins of trade. The model, which is based on Paul Krugman's (1980) framework, predicts that the impact of trade barriers on trade flows is dampened by the elasticity of substitution between goods, rather than magnified as in the traditional model with identical firms. The key findings are: 1. **Firm Heterogeneity and Productivity**: The model assumes that firms have Pareto-distributed productivity shocks, which is close to the observed size distribution of US firms. This heterogeneity introduces a new margin of adjustment: the extensive margin, which refers to the entry of new firms into the export market. 2. **Intensive and Extensive Margins**: The model decomposes the impact of trade barriers into two margins: the intensive margin, which is how much each existing exporter changes the size of its exports, and the extensive margin, which is how much new entrants export. 3. **Elasticity of Substitution**: The elasticity of substitution between goods has opposite effects on these margins. A higher elasticity of substitution magnifies the impact of trade barriers on the intensive margin but dampens it on the extensive margin. Conversely, a lower elasticity of substitution has the opposite effect. 4. **Empirical Evidence**: The model's predictions are supported by empirical evidence from studies on firm-level trade data. For example, Rauch (1999), Andersson (2007), Crozet and Koenig (2007), and Koenig (2005) find that trade barriers have a milder impact on trade volumes for more homogeneous goods, and that the extensive margin is quantitatively important in explaining aggregate trade flows. 5. **Conclusion**: The introduction of firm heterogeneity changes the predictions of the Krugman model. Trade barriers have a dampening effect on trade flows, not a magnifying one, when goods are more substitutable. This highlights the importance of firm heterogeneity in understanding the dynamics of international trade.This paper introduces firm heterogeneity into a simple model of international trade, focusing on the intensive and extensive margins of trade. The model, which is based on Paul Krugman's (1980) framework, predicts that the impact of trade barriers on trade flows is dampened by the elasticity of substitution between goods, rather than magnified as in the traditional model with identical firms. The key findings are: 1. **Firm Heterogeneity and Productivity**: The model assumes that firms have Pareto-distributed productivity shocks, which is close to the observed size distribution of US firms. This heterogeneity introduces a new margin of adjustment: the extensive margin, which refers to the entry of new firms into the export market. 2. **Intensive and Extensive Margins**: The model decomposes the impact of trade barriers into two margins: the intensive margin, which is how much each existing exporter changes the size of its exports, and the extensive margin, which is how much new entrants export. 3. **Elasticity of Substitution**: The elasticity of substitution between goods has opposite effects on these margins. A higher elasticity of substitution magnifies the impact of trade barriers on the intensive margin but dampens it on the extensive margin. Conversely, a lower elasticity of substitution has the opposite effect. 4. **Empirical Evidence**: The model's predictions are supported by empirical evidence from studies on firm-level trade data. For example, Rauch (1999), Andersson (2007), Crozet and Koenig (2007), and Koenig (2005) find that trade barriers have a milder impact on trade volumes for more homogeneous goods, and that the extensive margin is quantitatively important in explaining aggregate trade flows. 5. **Conclusion**: The introduction of firm heterogeneity changes the predictions of the Krugman model. Trade barriers have a dampening effect on trade flows, not a magnifying one, when goods are more substitutable. This highlights the importance of firm heterogeneity in understanding the dynamics of international trade.