The aim of this project is to investigate on one side, whether and how trade may induce innovation by existing firms, with particular attention to product innovation and competition strategies; on the other side, it aims at giving some insights on the relationship between firms’ heterogeneity and the aggregate effects of trade liberalization in the developed economies, taking into account the composition effects both within and between industries. It is now widely recognised the role played by trade liberalization in inducing self-selection of more efficient firms. However, a new, complementary, perspective will be offered according to which foreign markets represent a source of innovation and at the same time, they entail higher costs to collect information on foreign needs and their characteristics. This research will develop along two main lines. The first research line will investigate both empirically, by carrying out qualitative and quantitative analysis on European firm-level data, and theoretically, by providing different models in a theoretical framework of location in the ‘product space’, some potential sources of innovation through international interactions. Cross-country heterogeneity in i) buyer-seller relationships ii) the competitors’ distribution in the foreign market’s “product space”, and iii) consumer tastes, will be investigated. The second line of research consists in an attempt to single out what is the relevant industry level of aggregation in analysing the macroeconomic effects of trade liberalization with heterogeneous firms. A theoretical framework suitable to analyse the aggregate trade and growth effects of cross-country specialization across industries aggregated according to new criteria will be provided, and its implication will be empirically assessed. This framework will stress the macroeconomic implications of different dimensions of firms’ and industries heterogeneity.