SEMINAR: Economics Research Seminar

Abstract - This paper studies the relationship between income distribution and international trade in the canonical trade setting with one change. Under the standard approach prices are a function of constant marginal costs and constant elasticities alone, implying that information on consumer income is of no value to a typical firm. To address this limitation the strategy space is expanded to include non-linear prices ie potential to offer product lines. In equilibrium firms use information on the distribution of income to design a product for each income class, with associated prices that induce each group to optimally select their intended product. To achieve this outcome, some of these products are degraded relative to the first best while others exceed it. When countries with differing income distributions integrate, this has implications for the size of these distortions, influencing the gains from trade both within and across countries. The structure of trade and prices which emerge match a range of empirical patterns. The model also has novel implications for the speed of trade liberalization, industrial structure and factor prices. All these results are driven by firm strategy based on income difference alone as preferences are assumed to be identical and homothetic across countries, placing the distribution of income at the center of the analysis.