The Mode of Competition between Foreign and Domestic Goods, Pass-Through, and External Adjustment

We introduce Armington's (1969) notion of "origin differentiation" into a micro-founded model of pricing to market and examine how this affects the joint dynamics of prices and quantities in an international real business cycle framework. We find that the model, when calibrated using parameters that we structurally estimate from micro data on U.S. domestic and import prices, can match both movements in international relative prices and quantities as observed in the data. The mechanism that drives our results is that a moderate degree of substitutability between origins, combined with a high degree of substitutability between varieties from the same origin implies substantial variability in the markups of importers and limited spillovers into domestic prices, while at the same time it is consistent with a muted quantity response to such pronounced movements in relative prices.