How substitutable are foreign varieties: Estimation and application

Zhiying Gu, Purdue University


This dissertation consists of two essays. The first essay examines the manner in which product quality relates to product substitutability. The second essay builds on the insight from the first essay and applies the estimation framework from the first essay to study the impact of the surge in Chinese exports to the U.S. on developed countries. In the trade literature, researchers characterize product substitutability using own-price elasticities of demand. Cross-price elasticities are largely neglected due to the reliance on the CES demand structure, but this provides an incomplete picture of patterns of competition in the global market. To address this issue, I estimate cross price elasticities of import demand using a modified version of homothetic trans-log demand, and use freight rates as an instrumental variable for price changes. To estimate a feasible number of demand parameters, I classify countries into three groups based on income, and impose common parameters governing own and cross-price elasticities within each group. I find that cross-price elasticities are larger within an income-group than between income-groups, which is consistent with existing evidence concerning patterns of quality differentiation. In addition, own-price elasticities vary with income levels as well. They are the largest in magnitude for low-income countries reflecting a greater overall substitutability for low-income countries’ products. The second essay is an application of the methodology in the first essay. In this essay, I analyze the impact of the Chinese export growth on developed countries. To achieve this goal, I estimate product cross-price elasticities between China and high-income countries employing a trans-log demand system. Unlike the literature, this paper allows both product substitutes and complements by classifying disaggregated products into consumption, intermediate and capital goods. I find that Chinese consumption goods become closer substitutes to developed nations’ consumption goods after China’s accession to the WTO. This implies that Chinese trade liberalization has an adverse impact on high-income countries. However, the results also show that Chinese products have become more complementary to other nations’ intermediate and capital goods. This complementarity partially offsets the aforementioned adverse impact on developed nations when there is a drop in the price of Chinese goods.




Hummels, Purdue University.

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