Essays in international trade and theory of product differentiation

Volodymyr Lugovskyy, Purdue University

Abstract

This thesis includes three essays. Essay 1 extends the Dixit-Stiglitz (1977) model of monopolistic competition by relaxing the assumption of a single technology. The main objective is to study whether the equivalence of the monopolistically competitive equilibrium to the social optimum still holds in the extended model. I show that the answer crucially depends on the nature of the technological heterogeneity. If firms are free to choose from a common set of available technologies, and a free entry/exit condition holds to ensure a zero-profit equilibrium, then the Dixit-Stiglitz result is robust to the existence of heterogeneous firms. However, if firm-level productivity is drawn from a heterogeneous distribution, so that some intra-marginal firms earn positive profits, then the market equilibrium no longer has the same desirable properties. Models with CES preferences are commonly employed in the ‘new’ international trade literature, but these models generate counterfactual implications for the price elasticity of demand, and the rate of variety growth. Essay 2 generalizes Lancaster's ‘ideal variety’ model in order to better match empirical facts on trade. In particular, the strength of preference for the ideal variety depends on quantities consumed resulting in a price elasticity of demand that covaries positively with the market size and negatively with income per capita of the importer. Essay 3 generalizes Romer's (1994) story by endogenizing the number of domestic varieties. This accounts for the possibility that countries which are capable of producing more of their own capital goods will be less dependent on foreign imports. In Romer's model, all capital goods come from foreign sources so that domestic production cannot compensate for the absence of foreign variety. I allow domestic firms to produce capital goods so that the model solves simultaneously for the number of total varieties in the economy and the foreign/domestic split. The number of domestic varieties depends on fixed and variable costs of their production—countries with low costs of production can produce a greater set of domestic varieties and so import fewer foreign varieties. An implication is that welfare is more responsive to tariffs for countries with a lower potential for innovation.

Degree

Ph.D.

Advisors

Hummels, Purdue University.

Subject Area

Economics

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