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The home market effect and patterns of trade between rich and poor countries

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  • Matsuyama, Kiminori
Abstract
This paper proposes a new theoretical framework for studying the patterns of trade between rich and poor countries by incorporating nonhomothetic preferences into the standard home market effect models of trade. It has a continuum of Dixit-Stiglitz monopolistic competitive sectors with iceberg trade costs. There are two countries, which may differ in their per capita labor endowment and the population size. Preferences across sectors are such that, as per capita income goes up, the households shift their expenditure shares towards higher-indexed sectors. In equilibrium, the Rich country, whose households achieve higher standard-of-living, runs a trade surplus in higher-indexed sectors through the home market effect, and hence becomes a net-exporter of high income elastic goods. The framework is flexible enough to allow for a variety of comparative statics. For example, a uniform productivity improvement causes the Rich to switch from a net exporter to a net importer in some middle sectors. The Rich gains relatively more (less) from such changes than the Poor when the goods produced in different sectors are substitutes (complements). The effects of globalization, captured by a reduction in the trade cost, are similar to those of uniform productivity improvements, except that it has additional effects of the terms of trade change when the two countries are unequal in size.

Suggested Citation

  • Matsuyama, Kiminori, 2015. "The home market effect and patterns of trade between rich and poor countries," LSE Research Online Documents on Economics 86292, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:86292
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    References listed on IDEAS

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    6. Das, Satya P. & Sant’Anna, Vinicios P., 2023. "Determinants of bilateral trade in manufacturing and services: A unified approach," Economic Modelling, Elsevier, vol. 123(C).
    7. Thibault Fally, 2018. "Integrability and Generalized Separability," NBER Working Papers 25025, National Bureau of Economic Research, Inc.
    8. Diego Comin & Danial Lashkari & Martí Mestieri, 2021. "Structural Change With Long‐Run Income and Price Effects," Econometrica, Econometric Society, vol. 89(1), pages 311-374, January.
    9. Kiminori Matsuyama, 2019. "Engel's Law in the Global Economy: Demand‐Induced Patterns of Structural Change, Innovation, and Trade," Econometrica, Econometric Society, vol. 87(2), pages 497-528, March.
    10. Kim, Daisoon, 2021. "Economies of scale and international business cycles," Journal of International Economics, Elsevier, vol. 131(C).
    11. Masashige Hamano & Keita Oikawa, 2022. "Multi-Product Establishments and Product Dynamics," Working Papers e168, Tokyo Center for Economic Research.
    12. Matsuyama, Kiminori, 2017. "Beyond CES: Three Alternative Classes of Flexible Homothetic Demand Systems," CEPR Discussion Papers 12210, C.E.P.R. Discussion Papers.
    13. P. M. Picard & A. Tampieri, 2021. "Vertical differentiation and trade among symmetric countries," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(4), pages 1319-1355, June.
    14. Bo Gao & Bin Qiu, 2023. "Income distribution and unequal gains from trade," The World Economy, Wiley Blackwell, vol. 46(1), pages 236-255, January.
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    16. Lashkaripour, Ahmad, 2020. "Discrete trade," Journal of International Economics, Elsevier, vol. 126(C).

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