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The Home Market Effect and Patterns of Trade between Rich and Poor Countries

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  • Kiminori Matsuyama

    (Department of Economics Northwestern University
    Centre for Macroeconomics (CFM))

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 towards higher-indexed sectors. In equilibrium, the Rich (Poor) country, whose households achieve higher standard-of-living, runs a trade surplus in higher (lower)-indexed sectors through the home market effect, and hence becomes a net-exporter of high (low) income elastic goods. The framework is flexible enough to allow for a variety of comparative statistics. 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 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

  • Kiminori Matsuyama, 2015. "The Home Market Effect and Patterns of Trade between Rich and Poor Countries," Discussion Papers 1519, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:1519
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    References listed on IDEAS

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    2. 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.
    3. Arnaud Costinot & Dave Donaldson & Margaret Kyle & Heidi Williams, 2019. "The More We Die, The More We Sell? A Simple Test of the Home-Market Effect," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(2), pages 843-894.
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    6. Masashige Hamano & Keita Oikawa, 2022. "Multi-Product Establishments and Product Dynamics," Working Papers e168, Tokyo Center for Economic Research.
    7. Pamina Koenig, 2017. "Notes on Sigwatch's NGO campaign database," PSE Working Papers halshs-01671758, HAL.
    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. Matsuyama, Kiminori, 2017. "Beyond CES: Three Alternative Classes of Flexible Homothetic Demand Systems," CEPR Discussion Papers 12210, C.E.P.R. Discussion Papers.
    10. 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.
    11. Bradford, Scott C. & Das, Satya & Saha, Anuradha, 2022. "Country size, per-capita income, and comparative advantage: services versus manufacturing," MPRA Paper 115091, University Library of Munich, Germany.
    12. Bo Gao & Bin Qiu, 2023. "Income distribution and unequal gains from trade," The World Economy, Wiley Blackwell, vol. 46(1), pages 236-255, January.
    13. 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).
    14. Hartmut Egger & Simone Habermeyer, 2022. "How preferences shape the welfare and employment effects of trade," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 158(3), pages 815-853, August.
    15. Thibault Fally, 2018. "Integrability and Generalized Separability," NBER Working Papers 25025, National Bureau of Economic Research, Inc.
    16. Lashkaripour, Ahmad, 2020. "Discrete trade," Journal of International Economics, Elsevier, vol. 126(C).

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    More about this item

    Keywords

    Home market effect; Nonhomothetic preferences; Implicitly additively separable CES; Log-supermodularity; Monotone Likelihood Ratio; Monotone Comparative Statics; Product Cycles; Terms of Trade Effect; Leapfrogging;
    All these keywords.

    JEL classification:

    • J1 - Labor and Demographic Economics - - Demographic Economics

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