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Foundation of the Small Open Economy Model with Product Differentiation

Author

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  • Lorenzo Caliendo
  • Robert C. Feenstra

Abstract

We derive a small open economy (SOE) as the limit of an economy as the number or size of its trading partners goes to infinity and trade costs also go to infinity. We obtain this limit in the Armington, Eaton-Kortum, Krugman, and Melitz models. In all cases, the trade of the SOE with the foreign countries approaches a finite limit, and the domestic expenditure share for the SOE approaches a limit that is not zero or unity. The foreign countries can be either infinitely many SOEs, or alternatively, one or many large countries with domestic expenditure shares that approach unity. We illustrate the usefulness of this framework by obtaining a formula for the optimal tariff in the SOE -- depending on the elasticity of domestic wages with respect to the tariff -- that is consistent with all models.

Suggested Citation

  • Lorenzo Caliendo & Robert C. Feenstra, 2022. "Foundation of the Small Open Economy Model with Product Differentiation," NBER Working Papers 30223, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:30223
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    Cited by:

    1. Brandt, Loren & Lim, Kevin, 2024. "Opening up in the 21st century: A quantitative accounting of Chinese export growth," Journal of International Economics, Elsevier, vol. 150(C).
    2. Demidova, Svetlana & Kucheryavyy, Konstantin & Naito, Takumi & Rodríguez-Clare, Andrés, 2024. "The small open economy in a generalized gravity model," Journal of International Economics, Elsevier, vol. 152(C).
    3. Ignatenko, Anna & Lashkaripour, Ahmad & Macedoni, Luca & Simonovska, Ina, 2025. "Making America great again? The economic impacts of Liberation Day tariffs," Journal of International Economics, Elsevier, vol. 157(C).
    4. Farid Farrokhi & Ahmad Lashkaripour, 2025. "Can Trade Policy Mitigate Climate Change?," Econometrica, Econometric Society, vol. 93(5), pages 1561-1599, September.
    5. Kim, Jihee & Kim, Kyoochul & Park, Sangyoon & Sun, Chang, 2023. "The economic costs of trade sanctions: Evidence from North Korea," Journal of International Economics, Elsevier, vol. 145(C).
    6. John Chung, 2025. "Firm Heterogeneity, Misallocation, and Trade," Working Papers 25-33, Center for Economic Studies, U.S. Census Bureau.
    7. M.R. Malefane, 2023. "Economic implications of external monetary policy shocks for Lesotho: An empirical investigation," Journal of Economic Policy and Management Issues, JEPMI, vol. 2(2), pages 65-75.
    8. Jiang, Hong & Wang, Xue & Liu, Chongguang, 2024. "Automated machines and the labor wage gap," Technological Forecasting and Social Change, Elsevier, vol. 206(C).
    9. Caliendo, Lorenzo & Feenstra, Robert C. & Romalis, John & Taylor, Alan M., 2023. "A second-best argument for low optimal tariffs on intermediate inputs," Journal of International Economics, Elsevier, vol. 145(C).
    10. Hiau Looi Kee & Alessandro Nicita, 2024. "Quantifying economic impacts of trade agreements with heterogeneous trade elasticities," Review of International Economics, Wiley Blackwell, vol. 32(3), pages 1270-1299, August.

    More about this item

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations

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