International Trade and Monopolistic Competition Without CES: Estimating Translog Gravity
39 Pages Posted: 17 Apr 2010
Date Written: December 1, 2010
This paper derives a micro-founded gravity equation in general equilibrium based on a translog demand system that allows for endogenous markups and rich substitution patterns across goods. In contrast to standard CES-based gravity equations, trade is more sensitive to trade costs if the exporting country only provides a small share of the destination country’s imports. As a result, trade costs have a heterogeneous impact across country pairs, with some trade flows predicted to be zero. I test the translog gravity equation and find strong empirical support in its favor. In an application to the currency union effect, I find that a currency union is only associated with substantially higher bilateral trade if the exporting country provides a small share of the destination country’s imports. For other pairs, the currency union effect is modest or indistinguishable from zero.
Keywords: translog, trade costs, gravity, currency union, monopolistic competition, trade cost elasticity, heterogeneity, zero trade
JEL Classification: F11, F12, F15
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