Income Distribution, Product Quality, and International Trade

We develop a framework for studying trade in vertically and horizontally differentiated products. In our model, consumers with heterogeneous incomes and tastes purchase a homogeneous good as well as making a discrete choice of quality and variety of a differentiated product. The distribution of preferences in the population generates a nested logit demand structure. These demands are such that the fraction of consumers who buy a higher-quality product rises with income. We use the model to study the pattern of trade between countries that differ in size and income distributions but are otherwise identical. Trade - which is driven primarily by demand factors - derives from 'home market effects' in the presence of transport costs. The model helps to explain why richer countries export higher-quality goods. It provides a tractable tool for studying the welfare consequences of trade, transport costs, and trade policy for different income groups in an economy.