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Trade in Ideal Varieties: Theory and Evidence

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  • David Hummels
  • Volodymyr Lugovskyy

Abstract

Models with constant-elasticity of substitution (CES) preferences are commonly employed in the international trade literature because they provide a tractable way to handle product differentiation in general equilibrium. However this tractability comes at the cost of generating a set of counter-factual predictions regarding cross-country variation in export and import variety, output per variety, and prices. We examine whether a generalized version of Lancaster's 'ideal variety' model can better match facts. In this model, entry causes crowding in variety space, so that the marginal utility of new varieties falls as market size grows. Crowding is partially offset by income effects, as richer consumers will pay more for varieties closer matched to their ideal types. We show theoretically and confirm empirically that declining marginal utility of new varieties results in: a higher own-price elasticity of demand (and lower prices) in large countries and a lower own-price elasticity of demand (and higher prices) in rich countries. Model predictions about cross-country differences in the number and size of establishments are also empirically confirmed.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11828.

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Date of creation: Dec 2005
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Publication status: published as Hummels, David, and Volodymyr Lugovskyy. "International Pricing in a Generalized Model of Ideal Variety." Journal of Money, Credit, and Banking 41 (February 2009): 3-33.
Handle: RePEc:nbr:nberwo:11828

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  1. David Hummels & Alexandre Skiba, 2004. "Shipping the Good Apples Out? An Empirical Confirmation of the Alchian-Allen Conjecture," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 112(6), pages 1384-1402, December.
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Cited by:
  1. Joshua Aizenman, 2010. "Comment on "Exporting Deflation? Chinese Exports and Japanese Prices"," NBER Chapters, in: China's Growing Role in World Trade, pages 227-230 National Bureau of Economic Research, Inc.
  2. Klaus Desmet & Stephen L. Parente, 2006. "Market Size, Trade, and the Resistance to the Adoption of Better Technology," 2006 Meeting Papers, Society for Economic Dynamics 264, Society for Economic Dynamics.
  3. Goksel, Turkmen, 2012. "Financial constraints and international trade patterns," Economic Modelling, Elsevier, Elsevier, vol. 29(6), pages 2222-2225.
  4. Klaus Desmet & Stephen L. Parente, 2009. "The evolution of markets and the revolution of industry: A unified theory of growth," Working Papers, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales 2009-06, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales.
  5. Desmet, Klaus & Parente, Stephen, 2006. "Bigger is Better: Market Size, Demand Elasticity and Resistance to Technology Adoption," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5825, C.E.P.R. Discussion Papers.
  6. Tarr, David G., 2013. "Putting Services and Foreign Direct Investment with Endogenous Productivity Effects in Computable General Equilibrium Models," Handbook of Computable General Equilibrium Modeling, Elsevier.
  7. Laszlo Halpern & Miklos Koren & Adam Szeidl, 2006. "Imports and Productivity," 2006 Meeting Papers, Society for Economic Dynamics 796, Society for Economic Dynamics.
  8. Coibion, Olivier & Einav, Liran & Hallak, Juan Carlos, 2007. "Equilibrium demand elasticities across quality segments," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 25(1), pages 13-30, February.
  9. Philip Sauré, 2009. "Bounded Love of Variety and Patterns of Trade," Working Papers 2009-10, Swiss National Bank.
  10. László Halpern & Miklós Koren & Adam Szeidl, 2011. "Imported Inputs and Productivity," CeFiG Working Papers, Center for Firms in the Global Economy 8, Center for Firms in the Global Economy, revised 16 Sep 2011.
  11. Stephen L. Parente & Klaus Desmet, 2008. "The Evolution of Markets and the Revolution of Industry," 2008 Meeting Papers 688, Society for Economic Dynamics.
  12. Lukas Mohler, 2012. "Variety Gains and the Extensive Margin of Trade," Working papers, Faculty of Business and Economics - University of Basel 2012/16, Faculty of Business and Economics - University of Basel.
  13. Nakhoda, Aadil, 2013. "The impact of the exports of BRIC countries plus Turkey on the exports of Pakistan," MPRA Paper 52477, University Library of Munich, Germany.

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