Trade of Differentiated Goods:Heterogeneity of Consumers, Love of Quality and Quantity,and the Vertical Trade

Existing studies have found that the opening of trade results in the price-decreasing competition among horizontally differentiated goods and the quality upgrade of vertically differentiated goods, which results in the replacement of low-quality goods by high-quality goods. This paper spotlights what existing studies have overlooked and challenges these conventional results. First, this paper challenges the price decreasing competition by focusing on the heterogeneity of consumers. If each consumer has his own ideal good and the price elasticity of demand decreases with the distance from his ideal good, the opening of trade followed by the increase in the number of goods gives firms a chance to sell its product intensively to closer and less price elastic consumers. Facing lower price elastic consumers, firms will raise their prices after trade, and the price increasing competition is a result. In these days, we sometimes observe that high-quality goods from developed countries are replaced by low-quality goods from developing countries, which contradicts with predictions of conventional studies of vertically differentiated goods. One reason why conventional studies cannot show the replacement of high-quality goods is because most studies use a Unit-Demand (UD) model. The model implicitly assumes that consumers care the quality of goods but not the quantity of it. Without the volume effect, it less likely that inexpensive low-quality goods, which attract consumers with quantity rater than quality beat high-quality goods. This paper uses a new Non UD model, which relaxes the assumption of the UD and shows that producers of low-quality goods steal consumers from producers of high-quality goods if the income gap between two countries is large enough. Besides the UD assumption, another reason why existing studies predict the quality upgrade after trade is because they assume that consumers value quality so much that the utility value of the added quality always exceeds the cost of it. This paper relaxes the assumption and considers a case where the utility increases with quality at a decreasing rate. With severe concave utility function, numerical examples show that expensive high-quality goods from a developed country are replaced by inexpensive low-quality goods from a developing country