Is the Armington Elasticity Really Constant Across Importers?

Abstract:     
This paper shows that the Armington elasticity, which refers to both the elasticity of substitution across goods and the price elasticity of demand under the assumption of a large number of varieties, systematically changes from one importer country to another in an international trade context. Then a natural question to ask is "What determines the Armington elasticity?" The answer comes from the distinction between the elasticity of demand with respect to the destination price (i.e., the Armington elasticity) and the elasticity of demand with respect to the source price. Under additive trade costs, it is shown that the elasticity of demand with respect to the destination price is equal to the sum of the elasticity of demand with respect to the source price and the elasticity of demand with respect to the trade costs. The empirical results using the United States export data support this relation by showing that the Armington elasticity increases in trade costs and decreases in source prices; hence, it is more likely to have a constant elasticity of demand with respect to the source price rather than a constant Armington elasticity under additive trade costs. In terms of policy implications, the constant Armington elasticity undervalues the effects of a policy change around 3 or 4 times compared to the importer-specific Armington elasticities.

Keywords: Armington Elasticity, International Trade, Trade Ratios, State Exports, the United States

JEL Classifications: F12, F13, F14

Working Paper Series