Income distribution, product quality, and international trade

We develop a framework for studying trade in horizontally and ver-tically differentiated products. In our model, consumers with hetero-geneous incomes and tastes purchase a homogeneous good and make a discrete choice of quality and variety of a differentiated product. The distribution of preferences generates a nested-logit demand struc-ture such that the fraction of consumers who buy a higher-quality product rises with income. The model features a home-market effect that helps to explain why richer countries export higher-quality goods. It provides a tractable tool for studying the welfare consequences of trade and trade policy for different income groups in an economy. We are grateful to Aykut Ahlatçioğlu and Gabriel Kreindler for research assistance and to Juan Carlos Hallak, Jonathan Vogel, Yoram Weiss, and countless seminar participants for helpful comments and suggestions. Grossman and Helpman thank the National Science Foundation and Fajgelbaum thanks the International Economics Section at Princeton University for financial support. The paper was substantially revised while Grossman was a visiting research fellow in the Development Economics Vice Presidency at the World Bank. He thanks the World Bank for support and the Trade and Integration Team (DECTI) for its hospitality. Any opinions, findings, and conclusions or recommendations expressed in this paper are those of the authors and do not necessarily reflect the views of the National Science Foundation, the World Bank Group, or any other organization. 722 journal of political econom