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Within-country inequality and the patterns of trade

Foellmi, Reto; Schmid, Marco; Zweimüller, Josef (2023). Within-country inequality and the patterns of trade. URPP Equality of Opportunity Discussion Paper Series 17, University of Zurich.

Abstract

We introduce a demand-side trade model to shed light on the interaction between countries’ income distributions, the patterns of international trade and parallel trade policy restrictions in general equilibrium. We provide a comprehensive theoretical foundation for the role of income inequality for trade that allows distinguishing within- and between-country inequality. To bring differences in the willingness to pay of differentially rich consumers to the forefront of the analysis, we deviate from the canonical model by replacing the standard CES preferences with non-homothetic 0-1 preferences. We characterize and numerically solve the trade equilibrium for a discrete labor endowment distribution with several consumer-income groups. Our model predicts trade intensity to be increasing in the income distribution overlap, which is our preferred proxy for demand similarity. Our model, therefore, provides a theoretical foundation for the Linder hypothesis, that bilateral trade volume is increasing in the similarity of demand structure between two countries. Furthermore, our model predicts a Manhattan effect, capturing that poor consumers are badly off if they are a small minority in a predominantly rich country due to the high price level for basic products.

Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > URPP Equality of Opportunity Discussion Paper Series
08 Research Priority Programs > Equality of Opportunity
Dewey Decimal Classification:330 Economics
JEL Classification:F10, F12, F19
Uncontrolled Keywords:Within-country inequality, non-homothetic preferences, parallel imports, arbitrage, extensive margin, intensive margin, export zeros, North-South trade, income distribution similarity
Scope:Discipline-based scholarship (basic research)
Language:English
Date:April 2023
Deposited On:05 Jan 2024 14:15
Last Modified:06 Mar 2024 14:40
Series Name:URPP Equality of Opportunity Discussion Paper Series
Number of Pages:66
OA Status:Green
Official URL:https://www.urpp-equality.uzh.ch/dam/jcr:338d4019-830c-45f7-a0f5-939e454a93ad/17_FoellmiSchmidZweimueller2022_InequalityTrade.pdf
Related URLs:https://www.urpp-equality.uzh.ch/en/Discussion-Paper-Series.html
Other Identification Number:merlin-id:24215
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