Intra-industry trade and imperfect information about product quality

Abstract

This paper investigates the role of imperfect information on international trade in differentiated products. We construct a model within which we capture the feature of differential information, that is, when consumers' information about the quality of products varies according to the suppliers' country origin. Based on this feature we show that the patterns of trade are determined by both production and informational comparative advantage. These factors affect either the composition or the viability of exports of differentiated products. The nature of the impact on any particular country depends on whether this country is relatively more efficient in the production of low or high quality goods. The model generates two major results. First, it explains two-way trade in identical products. Second, it shows that imperfect information is sufficient to lead to the violation of the ‘law of one price’, i.e., in the same market identical products are priced differently. Furthermore, we investigate the impact of non-tariff barriers to trade such as minimum quality standards on imports as well as various types of subsidies, on the pattern of trade and the composition of trade in differentiated products.