Much of recent Trade theory focuses on heterogeneity of firms and the differential impact

trade policy might have on firms with different levels of productivity. A common problem is

that most firm level dataset do not contain information on output prices of firms which makes

it difficult to distinguish between productivity differences and differences in market power

between firms. This paper develops a new econometric framework that allows estimating

both firm specific productivity and market power in a semi-parametric way based on a

control function approach. The framework is applied to Chilean firm level data from the early

1980, shortly after the country underwent wide ranging trade reforms. The finding is that in

all sectors of the economy market power declined and productivity increased. In sectors with

higher import penetration productivity particularly at the bottom end of the distribution

increased faster. At the same time market power declined particularly so at the top end of the

market power distribution. We also show, that ignoring the effect on market power leads to

an underestimation of the positive effects of increased import penetration on productivity.