Verti-Zontal Differentiation in Monopolistic Competition

Abstract:     
The pattern of trade observed from firm-product-country data calls for a new generation of models. To address the unexplained variation in the data, we propose a new model of monopolistic competition where varieties enter preferences non-symmetrically, capturing both horizontal and vertical differentiation in an unprecedented way. Together with a variable elasticity of substitution, competition effects, varying markups and prices across countries, this results in a tractable model that rationalizes the empirical finding that firm-product quantities show systematically more variability than prices across export destinations. Accounting for unexplained data variation, our model can thus be used to improve demand identification.

Number of Pages in PDF File: 54

Keywords: heterogenous firms, horizontal differentiation, monopolistic competition, non-symmetric varieties, vertical differentiation

JEL Classification: D43, F12, F14, L16

working papers series