A Generalized CES Demand System and Gains from Trade with Heterogeneous Income and Price Elasticities

Martí Mestieri

No 386, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Micro-level studies robustly document heterogeneity in price and income elasticity of goods produced by different industries or firms. How- ever, this heterogeneity is absent from most theories of aggregate and macro- level phenomena. In this paper, we provide a flexible yet tractable general-equilibrium framework for the study of heterogeneity in price and income elasticity across goods. We first show that a broad class of demand systems that either focus on price or income elasticity heterogeneity implicitly impose strong restrictions on the correlation between income and price elasticities across goods. We show that data on trade flows does not support such correlations for import demand. We provide a generalization of the standard CES preferences that flexibly allows for general patterns of correlations between income and price elasticity. As an application of our demand system, we embed it in a Ricardian model of international trade and show it implies intuitive corrections to the standard results for the welfare gains from trade. These corrections stem from the fact that the gains from access to new varieties strongly hinge on the price and income elasticity composition of the traded goods. Empirically, we show that these compositional effects result in substantially higher welfare gains from trade in rich relative to poor countries.

Date: 2017
New Economics Papers: this item is included in nep-int
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:386

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