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International Arbitrage and the Extensive Margin of Trade between Rich and Poor Countries

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  • Reto Foellmi
  • Christian Hepenstrick
  • Zweimüller Josef

Abstract

We incorporate consumption indivisibilities into the Krugman (1980) model and show that an importer's per capita income becomes a primary determinant of “export zeros”. Households in the rich North (poor South) are willing to pay high (low) prices for consumer goods; hence, unconstrained monopoly pricing generates arbitrage opportunities for internationally traded products. Export zeros arise because some northern firms abstain from exporting to the South, to avoid international arbitrage. Rich countries benefit from a trade liberalization, while poor countries lose. These results hold also under more general preferences with both extensive and intensive consumption margins. We show that a standard calibrated trade model (that ignores arbitrage) generates predictions on relative prices that violate no-arbitrage constraints in many bilateral trade relations. This suggests that international arbitrage is potentially important.

Suggested Citation

  • Reto Foellmi & Christian Hepenstrick & Zweimüller Josef, 2018. "International Arbitrage and the Extensive Margin of Trade between Rich and Poor Countries," Review of Economic Studies, Oxford University Press, vol. 85(1), pages 475-510.
  • Handle: RePEc:oup:restud:v:85:y:2018:i:1:p:475-510.
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    File URL: http://hdl.handle.net/10.1093/restud/rdx016
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    Citations

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    Cited by:

    1. Foellmi, Reto & Hanslin Grossmann, Sandra & Kohler, Andreas, 2018. "A dynamic North-South model of demand-induced product cycles," Journal of International Economics, Elsevier, vol. 110(C), pages 63-86.
    2. repec:eee:inecon:v:110:y:2018:i:c:p:87-102 is not listed on IDEAS
    3. Fensore, Irene & Legge, Stefan & Schmid, Lukas, 2017. "Human Barriers to International Trade," Economics Working Paper Series 1712, University of St. Gallen, School of Economics and Political Science.
    4. Matsuyama, Kiminori, 2017. "Engel's Law in the Global Economy: Demand-induced Patterns of Structural Change, Innovation, and Trade," CEPR Discussion Papers 12387, C.E.P.R. Discussion Papers.
    5. A. Auer, Raphael & Chaney, Thomas & Sauré, Philip, 2018. "Quality pricing-to-market," Journal of International Economics, Elsevier, vol. 110(C), pages 87-102.
    6. Hartmut Egger & Simone Habermeyer, 2019. "Nonhomothetic preferences and rent sharing in an open economy," CESifo Working Paper Series 7522, CESifo Group Munich.

    More about this item

    Keywords

    Non-homothetic preferences; Parallel imports; Arbitrage; Extensive margin; Export zeros;

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F19 - International Economics - - Trade - - - Other

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