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Distorted trade barriers: a comment on “distorted gravity"

Matthew Cole ()

No 201019, Working Papers from School of Economics, University College Dublin

Abstract: Since firm heterogeneity has been introduced into international trade models, the importance of firm entry and exit (the extensive margin) has been highlighted. Thomas Chaney (2008) illustrates how accounting for heterogenous firms (and this extensive margin) alters the standard gravity equation. In particular, it reverses the previously predicted effect the elasticity of substitution has on the elasticity of trade flows. Further, Chaney shows that the elasticity of trade flows with respect to variable trade costs is a constant. As is common, iceberg transport costs are used as the variable trade barrier. However, in many empirical studies, ad valorem tariffs are also used as a form of trade barrier, which as Cole (2010) points out, is not isomorphic to iceberg transport cost in a monopolistically competitive setting. In this comment, I solve the Chaney (2008) model using ad valorem tariffs instead of iceberg transport costs and show the elasticity of trade flows with respect to tariffs is not constant, but depends on the elasticity of substitution.

Keywords: Intra-industry trade; Gravity; Firm heterogeneity; Monopolistic competition; Intra-industry trade--Econometric models; Monopolistic competition; Barriers to entry (Industrial organization) (search for similar items in EconPapers)
JEL-codes: F10 F12 F17 (search for similar items in EconPapers)
Date: 2010-06
New Economics Papers: this item is included in nep-int
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