Product imitation and policies of a developing country

The first chapter sets up the basic model of North-South trade. North innovates new variety of products and South imitates the old varieties that previously innovated and produced in the North. South has to invest R&D labor, which reduces the southern production cost to be able to compete in the market. The second chapter considers two industrial policies of South, R&D subsidy and entry subsidy to imitators. The effects of the subsidy depend on the unit cost gap between the North and the South. If the cost gap turned out to be narrow, zero R&D subsidy with a small subsidy to entry can raise the welfare of the southern consumers. If the cost gap is wide so that the southern firms can charge the optimal unconstrained monopoly price that, given demand assumptions, is a fixed mark up over the unit cost, the optimal R&D subsidy is positive. This subsidy raises the consumption of imitation varieties but reduces the number of the varieties. The last chapter is an empirical study that investigates the role of exchange rate on the trade flows. The bilateral data between U.S. and Canada are disaggregated into five "end-use" categories. Co-integration among the trade flow of each category, its relative price and the relative income of the two countries is tested to see if those variables maintained any long-run equilibrium relationship. Also short-run dynamics are checked through error correction model to measure how much the real exchange rates or the relative prices influence the trade flows.