Modeling of International Trade with Variable Elasticity of Substitution of Varieties

<p>The model of international trade with variable elasticity of substitution (VES) of varieties is studied in this work. The model includes is 1-sector 1-facor 2-country homogenous economy, where countries differ in sizes. Also I study the impact of relative market size and transportation cost on equilibrium.</p><p>The main attention is paid to comparative statics of equilibrium variables: relative wage, consumption of domestic and imported variety per worker, prices, the sizes of firms, the number of firms in each country and the trade flows between two countries with respect of changing in relative size of a country or transportation costs. The key feature of this work is that I do not use standard constant elasticity of substitution (CES) preferences, but more general functional with VES-preferences that includes CES-case.&nbsp; The reason of using more general preference system is that CES-preferences lead to inconsistent results (prices and sizes of firms are constant with respect of market size).</p><p>The purpose of this work is to complete comparative statics in 2 parameters: (i) country-labor share and (ii) trade cost. In doing so we want to get to know if departure from CES-function will lead to price-increasing and price-decreasing competition, for outputs to increase or decrease, for relative wage growing, impact on the mass of firms in each country and Home-Market Effect. And, if increasing or decreasing elasticity of the inverse demand influence on the sign of these effects.</p><p>&nbsp;In this paper several tasks are completed. First of all I formulate the problem and investigate the literature that is linked with this problem. Then I construct the model that is needed to study this problem. And after this I represent my results.</p><p>The main result that is made in this work is the description of global simulations of comparative statics of the model for different utility function specifications and for different model parameters. In overall more than 10000 numerical examples were made. The results of this global simulation can be divided into two parts: (i) comparative statics with respect of transportation costs and (ii) relative market size. I conclude that the departure from CES-function allow to uncover new trade effects. Also the economic interpretation of this affects are mentioned.</p>