Product differentiation, firm heterogeneity and international trade: Exploring the Alchian-Allen effect

In a model of international trade with horizontally differentiated goods, increasing returns and monopolistically competitive markets, this paper proposes that the degree of differentiation in a product mix-defined as the ratio of the number of varieties to the total value of imports-can be regarded as another aspect of quality. Furthermore, this paper draws a parallel to the Alchian-Allen effect and shows that, when firms are heterogeneous in either fixed or variable costs, the degree of differentiation is increasing in per unit transportation costs. (C) 2009 University of Venice. Published by Elsevier Ltd. All rights reserved.