TY  - JOUR
AU  - Hummels,David
AU  - Lugovskyy,Volodymyr
TI  - Trade in Ideal Varieties: Theory and Evidence
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 11828
PY  - 2005
Y2  - December 2005
UR  - http://www.nber.org/papers/w11828
L1  - http://www.nber.org/papers/w11828.pdf
N1  - Author contact info:
David Hummels
Krannert School of Management
403 West State Street
Purdue University
West Lafayette, IN  47907-1310
Tel: 765/494-4495
Fax: 765/494-9658
E-Mail: hummelsd@purdue.edu

Volodymyr Lugovskyy
School of Economics
Georgia Institute of Technology
Atlanta, Georgia 30332-0615
E-Mail: volodymyr.lugovskyy@econ.gatech.edu
AB  - 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.
ER  -