Quality, Variable Markups, and Welfare: A Quantitative General Equilibrium Analysis of Export Prices

Abstract

Modern trade models attribute the dispersion of international prices to physical and man-made barriers to trade, to the pricing-to-market by heterogeneous producers, and to differences in the quality of output offered by firms. This paper analyzes a quantitative general equilibrium model that incorporates all three of these mechanisms. Estimating the model's parameters from Chinese firm-level trade data, we find that our model incorporating both endogenous quality and per unit trade costs implies lower gains from trade relative to the model without variable quality. This is because these costs, combined with "Washington Apples" effects, are a greater burden on the most productive firms and change the effective distribution of productivity. We also show that changes in specific trade costs induce larger shifts in export prices than do changes in ad valorem trade costs that equivalently restrict trade. The results highlight the importance of modeling "Washington Apples" effects in quantitative trade models.

Keywords: Quality, Welfare, Variable Markups, Export Price, “Washington Apples” Effect, Non-Homothetic Preferences, Specific Trade Costs, Heterogeneous Firms

JEL Classification: F12, F14