Markups Versus Trade Costs

Abstract:     
Introducing and estimating a class of monopolistically competitive models using data on international trade, we compare the implications of having constant versus variable markups across importers. The main innovation, which makes the overall analysis very simple and tractable, is that, when trade implications are estimated, having cases of constant versus variable markups is reduced to using quantities in logs versus levels on the left hand side of the estimated equations, where the right hand sides are exactly the same; i.e., constant markups correspond to log-linear regressions, while variable markups correspond to lin-log regressions. For the median good, variable markups imply higher welfare gains from reducing trade costs compared to constant markups. The results are mostly driven by the decomposition of the deviations from the Law of One Price across destination countries, where the contribution of trade costs is estimated higher in the case of variable markups.

Number of Pages in PDF File: 66

Keywords: Functional Separability, Variable Markups, Trade Costs, Price Elasticity of Demand, Income Elasticity of Demand

JEL Classification: F12, F13, F14

working papers series