7. Differentiated Products, International Trade, and Simple General Equilibrium Effects

Abstract

Using a simple general equilibrium model with two countries and two sectors including one manufacturing sector producing (vertically) difierentiated products, we flrst show that an international barrier to trade in the manufacturing sector creates inter-industry trade, whereas an international barrier to trade in the other sector generates intra-industry trade among vertically difierentiated products. We generalize the model to arbitrary (but feasible) symmetric levels of barriers to trade in both sectors and investigates its implications for trade liberalization. In particular, the empirically observed increase in intra-industry trade in vertically difierentiated products is shown to be consistent with general equilibrium efiects associated with deeper trade liberalization in the manufacturing sector than in the nonmanufacturing sector.