Love of variety in trade models with product differentiation

Abstract

This paper explores the key role of importer's love of variety in applied general equilibrium models featuring product differentiation. The paper compares the Armington-, Krugman-, and Melitz-type trade specifications. Experimental simulations with the model reveal that as love of variety weakens, based on the empirical evidence revealed by Ardelean (2006), the models with homogeneous firms may generate larger welfare gains than the Melitz-type heterogeneous firm model. This stands in marked contrast to the findings of Melitz and Redding (2013), based on the assumption of maximum valuation on increasing variety.