DP8752 Verti-zontal Differentiation in Monopolistic Competition

Author(s): Francesco Di Comite, Jacques-François Thisse, Hylke Vandenbussche
Publication Date: January 2012
Keyword(s): heterogenous firms, horizontal differentiation, monopolistic competition, non-symmetric varieties, vertical differentiation
JEL(s): D43, F12, F14, L16
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8752

The pattern of trade observed from firm-product-country data calls for a new generation of models. To address the unexplained variation in the data, we propose a new model of monopolistic competition where varieties enter preferences non-symmetrically, capturing both horizontal and vertical differentiation in an unprecedented way. Together with a variable elasticity of substitution, competition effects, varying markups and prices across countries, this results in a tractable model that rationalizes the empirical finding that firm-product quantities show systematically more variability than prices across export destinations. Accounting for unexplained data variation, our model can thus be used to improve demand identification.