Quality, Valuation, and Welfare

The analytic structure developed in the first six chapters is applied to quality-differentiated production, quality-differentiated pricing, and consumer welfare analysis. The quality-differentiated production problem is developed as a special case of the multiple-output problem for both nonstochastic and stochastic pricing regimes. The "household production" model of Gorman (1956) and Lancaster (1966) is developed in a conjugate dual framework whose solution for rational individuals obeys the zero-maximum (zero minimum) principle. The nominal concepts of compensating variation and equivalent variation are shown to have real-valued (dual) parallels in the compensating benefit and the equivalent benefit. Real, as opposed to nominal, valuation for traded and nontraded goods is treated in the benefit framework. Directional derivatives of distance functions are used to rationalize the frequently observed empirical discrepancy between willingness-to-pay and willingness-to-accept.

FISCAL SHOCKS IN A TWO-SECTOR OPEN ECONOMY WITH ENDOGENOUS MARKUPS

We use a two-sector neoclassical open economy model with traded and nontraded goods and endogenous markups to investigate the effects of temporary fiscal shocks. One central finding is that theory can be reconciled with evidence once we allow for endogenous markups and assume that the traded sector is more capital-intensive than the nontraded sector. More precisely, although both ingredients are essential to produce the real exchange rate depreciation, only the second ingredient is necessary to account for the simultaneous decline in investment and the current account, in line with the evidence.