Long-Run Supply Effects and the Elasticities Approach to Trade

23 Pages Posted: 24 Mar 2003

Date Written: January 2003

Abstract

Krugman (1989) argued that differences across countries in estimated income elasticities of import demand are due to omission of an exporter supply effect. He showed that such an effect can be derived in a theoretical model with economies of scale in production and a taste for variety in consumption. In his model, countries grow by producing new varieties of goods, and they are able to export these goods without suffering any deterioration in their terms of trade. This paper analyzes U.S. import demand from different source countries and finds strong evidence of a supply effect of roughly half the magnitude (0.75) of the income elasticity (1.5). Price elasticities for the most part are estimated close to -1, which is typical for the literature. Exclusion of the supply effect leads to overestimation of the income elasticity. Results based on U.S. exports to different destinations are less robust, but largely corroborate these findings.

Keywords: import demand, income elasticity, international trade, product differentiation

JEL Classification: F1, F4

Suggested Citation

Gagnon, Joseph, Long-Run Supply Effects and the Elasticities Approach to Trade (January 2003). FRB International Finance Discussion Paper No. 754. Available at SSRN: https://ssrn.com/abstract=375121 or http://dx.doi.org/10.2139/ssrn.375121

Joseph Gagnon (Contact Author)

Peterson Institute ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

HOME PAGE: http://www.piie.com

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