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Globalization and the Gains from Variety: The Case of a Small Open Economy

  • Lukas Mohler

Since the pioneering work of Krugman (1980) economists try to quantify the welfare gains from an increase in traded variety. The seminal work of Feenstra (1994) and its application to the U.S. of Broda and Weinstein (2006) allowed this quantification for the first time using highly disaggregated trade data. In this paper it is argued that size and openness of a country are important factors in determining these welfare gains. The gains from traded variety of a small open economy are calculated and compared to those of the U.S.; the differences between the countries are then analysed carefully. To achieve this, the methodology of Feenstra (1994) is extended. While the Armington definition of a variety forces the researcher to assume no growth at the extensive margin, in this paper the Feenstra ratios are reinterpreted in a way that allows for full growth at the extensive margin. The resulting two polar cases will influence the country comparison with respect to the gains from variety: Depending on how much growth at the extensive margin a researcher is willing to assume, the relative gains from variety of a small open economy compared to a larger economy like the U.S. are changed. It is also argued that this result may hold generally for other small and large OECD economies.

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Paper provided by FIW in its series FIW Working Paper series with number 031.

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Length: 31
Date of creation: Apr 2009
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Handle: RePEc:wsr:wpaper:y:2009:i:031
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  1. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  2. Robert C. Feenstra, 1991. "New Goods and Index Numbers: U.S. Import Prices," NBER Working Papers 3610, National Bureau of Economic Research, Inc.
  3. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
  4. Jerry A. Hausman, 1994. "Valuation of New Goods under Perfect and Imperfect Competition," NBER Working Papers 4970, National Bureau of Economic Research, Inc.
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  9. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
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  12. Lancaster, Kelvin, 1975. "Socially Optimal Product Differentiation," American Economic Review, American Economic Association, vol. 65(4), pages 567-85, September.
  13. Spence, Michael, 1976. "Product Selection, Fixed Costs, and Monopolistic Competition," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 217-35, June.
  14. Jerry A. Hausman, 1997. "Valuing the Effect of Regulation on New Services in Telecommunications," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1997 Micr), pages 1-54.
  15. Diewert, W. E., 1976. "Exact and superlative index numbers," Journal of Econometrics, Elsevier, vol. 4(2), pages 115-145, May.
  16. Robert C. Feenstra, 1992. "How Costly Is Protectionism?," Journal of Economic Perspectives, American Economic Association, vol. 6(3), pages 159-178, Summer.
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  18. Krugman, Paul R., 1979. "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479, November.
  19. Murray C. Kemp, 1962. "Errors Of Measurement And Bias In Estimates Of Import Demand Parameters1," The Economic Record, The Economic Society of Australia, vol. 38(83), pages 369-372, 09.
  20. Kelvin J. Lancaster, 1966. "A New Approach to Consumer Theory," Journal of Political Economy, University of Chicago Press, vol. 74, pages 132.
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