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A Simple Model of Quality Heterogeneity and International Trade

This paper develops a trade model with firm-specifc quality heterogeneity, limit pricing, and an endogenous distribution of markups. Exposure to trade induces only the firms producing high-quality (high-price) products to enter the export markets, whereas firms producing low-quality (low-price) products serve the domestic market in accor- dance to the Alchian and Allen (1964) conjecture. Trade liberalization intensifies the competition; causes firms producing low-quality products to exit the market; increases the number of products consumed in each country; and generates quality upgrading that results in higher average domestic and export markups. The welfare effect of trade liberalization is ambiguous because the laissez-faire markups can be greater or lower than the socially optimal markups.

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Paper provided by Department of Economics, Louisiana State University in its series Departmental Working Papers with number 2009-04.

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Handle: RePEc:lsu:lsuwpp:2009-04
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