Trade in Ideal Varieties: Theory and Evidence

David Hummels, Volodymyr Lugovskyy

NBER Working Paper No. 11828
Issued in December 2005
NBER Program(s):   ITI

Models with constant-elasticity of substitution (CES) preferences are commonly employed in the international trade literature because they provide a tractable way to handle product differentiation in general equilibrium. However this tractability comes at the cost of generating a set of counter-factual predictions regarding cross-country variation in export and import variety, output per variety, and prices. We examine whether a generalized version of Lancaster's 'ideal variety' model can better match facts. In this model, entry causes crowding in variety space, so that the marginal utility of new varieties falls as market size grows. Crowding is partially offset by income effects, as richer consumers will pay more for varieties closer matched to their ideal types. We show theoretically and confirm empirically that declining marginal utility of new varieties results in: a higher own-price elasticity of demand (and lower prices) in large countries and a lower own-price elasticity of demand (and higher prices) in rich countries. Model predictions about cross-country differences in the number and size of establishments are also empirically confirmed.

download in pdf format
   (653 K)

email paper

This paper is available as PDF (653 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w11828

Published: Hummels, David, and Volodymyr Lugovskyy. "International Pricing in a Generalized Model of Ideal Variety." Journal of Money, Credit, and Banking 41 (February 2009): 3-33.

Users who downloaded this paper also downloaded these:
Hummels and Klenow w8712 The Variety and Quality of a Nation's Trade
Choi, Hummels, and Xiang w12531 Explaining Import Variety and Quality: The Role of the Income Distribution
Hillberry and Hummels w11339 Trade Responses to Geographic Frictions: A Decomposition Using Micro-Data
Hummels and Skiba w9023 Shipping the Good Apples Out? An Empirical Confirmation of the Alchian-Allen Conjecture
Hummels and Schaur w17758 Time as a Trade Barrier
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us