Abstract
This paper is based on New Open Economy Macroeconomics as the theoretical foundation thereby applying the principle of comparative advantage of the international trade theory to open economics for finding out the effect of the change in the number of varieties on a set of macroeconomic variables in a country, such as consumption, price, output, terms of trade, and exchange rate, as well as the role of computation home bias. This paper finds that under the long-run, an increase in the number of varieties will have positive effects on consumption and terms of trade, but negative effects on output, price index, as well as exchange rate. The effect of changes in the number of varieties on world consumption is ambiguous. It depends upon the degree of home bias in consumption. If home consumption is biased towards home (foreign) goods, then an increase in the number of varieties can cause an increase (decrease) in world consumption.
Highlights
In 1817, David Ricardo proposed the theory of “Comparative Advantage” in his book, “The Principles of Political Economy and Taxation”
We attempt in this paper to combine the model of international trade proposed by Ricardo and open economics with the use of New Open Economy Macroeconomics to find out the effect of the change in the number of varieties on a set of macroeconomic variables in a country, such as consumption, price, output, terms of trade, and exchange rate so as to extend the contribution of Ricardo (1817), Hicks (1953), Gomory and Baumol (2000), and Samuelson (2004) to open economics
We investigate the role of home bias in consumption in the process of the influence of number of varieties change on the macroeconomic variables
Summary
In 1817, David Ricardo proposed the theory of “Comparative Advantage” in his book, “The Principles of Political Economy and Taxation”. It is clear that existing literature lacks a complete theoretical basis and the research of the effects of changes in the number of varieties and consumption home bias on open economy. To remedy such regrets, this paper connected the theory of comparative advantage and consumption home bias on an open economy in NOEM framework.
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