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Gains from Trade under Quality Uncertainty

Author

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  • Kunal Dasgupta
  • Jordi Mondria

Abstract

We add quality uncertainty to a two-country trade model with CES preference and monopolistic competition. There are two kinds of firms - low quality and high quality. Quality is perfectly observable in the domestic market but not in the foreign market. Exporters use price to signal their quality. It is now well established that in such a model with full information, the welfare gains from trade (GFT) can be captured by a sufficient statistic that depends on domestic trade share and the elasticity of substitution. In contrast, in a model with asymmetric information, we show that within the class of separating equilibria, the sufficient statistic always under-estimates GFT, while within the class of pooling equilibria, the sufficient statistic could over-estimate GFT. Nevertheless, GFT are always positive. For an equilibrium refinement, we analyze the determinants of GFT. We show that the actual GFT under asymmetric information could be almost 2.5 times higher than that measured using the sufficient statistic approach.

Suggested Citation

  • Kunal Dasgupta & Jordi Mondria, 2015. "Gains from Trade under Quality Uncertainty," Working Papers tecipa-526, University of Toronto, Department of Economics.
  • Handle: RePEc:tor:tecipa:tecipa-526
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    References listed on IDEAS

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    More about this item

    Keywords

    Quality uncertainty; asymmetric information; signalling; gains from trade;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • F10 - International Economics - - Trade - - - General
    • F19 - International Economics - - Trade - - - Other
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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