The Small-Open Economy in a Generalized Gravity Model

Svetlana Demidova, Konstantin Kucheryavyy, Takumi Naito and Rodríguez-Clare, Andres

No 19223, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: To provide sharp answers to basic questions in international trade, a standard approach is to focus on a small open economy (SOE). Whereas the classic tradition is to define a SOE as an economy that takes world prices as given, in the new trade literature it is defined instead as one that takes foreign-good prices and export demand schedules as given. We develop a gravity model that nests all its standard microfoundations and show how to take the limit so that an economy that becomes infinitesimally small behaves like a SOE. We then derive comparative statics and optimal policy for the SOE. Ignoring standard tax indeterminacies, optimal policy is characterized by export taxes and import tariffs equal to the (inverse) foreign demand and supply elasticities, respectively, and employment subsidies determined by the scale elasticity (under perfect competition) or markups (under monopolistic competition)

Keywords: Gravity; equation (search for similar items in EconPapers)
JEL-codes: F10 F11 F12 F13 (search for similar items in EconPapers)
Date: 2024-07
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Journal Article: The small open economy in a generalized gravity model (2024)
Working Paper: The Small Open Economy in a Generalized Gravity Model (2022)
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