Archived Internet Comments


Liu, Xuepeng: A political-economic analysis of free-trade agreements: Comment (originally posted as an AER Internet-only comment in 2006)

Abstract: In his paper in the American Economic Review, Levy (1997) develops a political economy model of free-trade agreements (FTAs). He emphasizes that the homotheticity restriction of the production function assumed for the differentiated product is crucial for his model. This comment shows that this homotheticity assumption is unnecessary and actually problematic. It is problematic in the sense that the model ends up not having a "well-defined" equilibrium. I fix this problem and rework the model using a different production function with fixed cost. This comment also points out that the necessity of the homotheticity restriction on the production function of differentiated goods is a common misunderstanding in trade literature. (JEL: F15)