Events

Economics Seminar

Author:

• Phillip McCalman
  University of Melbourne

This paper develops a monopolistically competitive model of international trade where firms give consumers the option to “super-size” their consumption. Such a strategy is a response to consumer heterogeneity (e.g. income differences) and is implemented via second degree price discrimination (i.e. offering a menu of products to choose from). Allowing firms this option not only has implications for outcomes in an open economy, but also more broadly for models of competition and price discrimination. Compared to a monopoly model of second degree price discrimination it is shown that a firm always offers a complete product-line (i.e. all types are served in equilibrium). Hence, competition is associated with greater firm scope. However, the principle of “no distortion at the top” no longer applies, with high types offered an excessively lavish product at the same time low types receive an inferior product relative to the first best. Thus distortions are pervasive in this setting and occur in both directions. Allowing firms to offer “super-sized” products also has a number of important implications for how international integration is perceived. Relative to the standard model of single product firms it is shown that the volume of trade, number of varieties and welfare are all higher when firms use a product-line to indirectly discriminate. This suggests that the standard model substantially under-predicts the potential benefits of international integration. In addition, it is shown that a country's distribution of income is an important determinant of the gains from trade. In particular, countries with a “good” distribution of income receive magnified gains while those with a “bad” distribution have their gains diminished.