General equilibrium analysis of the Eaton–Kortum model of.pdf

ARTICLE IN PRESS Journal of Monetary Economics 54 (2007) 1726–1768 /locate/jme General equilibrium analysis of the Eaton–Kortum model of international trade $ a b, Fernando Alvarez , Robert E. Lucas, Jr. a University of Chicago and NBER, USA b University of Chicago and Federal Reserve Bank of Minneapolis, USA Received 25 July 2005; received in revised form 7 June 2006; accepted 25 July 2006 Available online 19 December 2006 Abstract We study a variation of the Eaton–Kortum model, a competitive, constant-returns-to-scale multicountry Ricardian model of trade. We establish existence and uniqueness of an equilibrium with balanced trade where each country imposes an import tariff. We analyze the determinants of the cross-country distribution of trade volumes, such as size, tariffs and distance, and compare a calibrated version of the model with data for the largest 60 economies. We use the calibrated model to estimate the gains of a world-wide trade elimination of tariffs, using the theory to explain the magnitude of the gains as well as the differential effect arising from cross-country differences in pre- liberalization tariff levels and country size. r 2006 Elsevier B.V. All rights reserved. Keywords: General equilibrium; Ricardian trade theory; Trade volume; Tariff policy $ We thank Jonathan Eaton, Tim Kehoe, Sam Kortum, Ellen McGrattan, Sergey Mityakov, Casey Mulligan, John Romalis, Kim Ruhl, Ed Prescott, Phil Reny, Rob Shimer, Nancy Stokey, Chad Syverson, Ivan Werning