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Non-homothetic preferences, parallel imports and the extensive margin of international trade

  • Reto Foellmi
  • Christian Hepenstrick
  • Josef Zweimüller

We study international trade in a model where consumers have non-homothetic preferences and where household income restricts the extensive margin of consumption. In equilibrium, monopolistic producers set high (low) prices in rich (poor) countries but a threat of parallel trade restricts the scope of price discrimination between countries. The threat of parallel trade allows differences in per capita incomes to have a strong impact on the extensive margin of trade, whereas differences in population sizes have a weaker effect. We also show that the welfare gains from trade liberalization are biased towards rich countries. We extend our model to more than two countries; to unequal incomes within countries; and to more general specifications of non-homothetic preferences. Our basic results are robust to these extensions.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 497.

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Date of creation: Jul 2010
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Handle: RePEc:zur:iewwpx:497
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