Reports & Publications

Behavioral Characteristics of Applied General Equilibrium Models with Variable Elasticity of Substitution between Varieties from Different Sources

Discussion Papers

No.740

by Kazuhiko Oyamada

February 2019

ABSTRACT

This study explores the behavioral characteristics of the Melitz-type heterogeneous and the Krugman-type homogeneous firm models that endogenize substitution elasticity as an increasing function of the total number of varieties that are available in each destination country/region. Using a case the United States (US) liberalizes imports of manufactured products from China as an example, simulation experiments with a three-region, three-sector applied general equilibrium model of global trade revealed that economic agents comply with more inefficient circumstances when the importer's preference for variety intensifies. Whereas, a more efficient environment enables countries, including those excluded from a free trade agreement, to receive welfare gains when the influence of the total number of varieties to the substitution elasticity becomes strong.

Keywords: variable elasticity of substitution, preference for variety, heterogeneous firms

JEL classification: C68, D58, F12, L11

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