Changes in the Number of Varieties, Consumption Home Bias and Long-Run Macroeconomic Fluctuations

Abstract

This paper is based on New Open Economy Macroeconomics as the theoretical foundation thereby applying the principle of comparative advantage of the international trade theory to open economics for finding out the effect of the change in the number of varieties on a set of macroeconomic variables in a country, such as consumption, price, output, terms of trade, and exchange rate, as well as the role of computation home bias. This paper finds that under the long-run, an increase in the number of varieties will have positive effects on consumption and terms of trade, but negative effects on output, price index, as well as exchange rate. The effect of changes in the number of varieties on world consumption is ambiguous. It depends upon the degree of home bias in consumption. If home consumption is biased towards home (foreign) goods, then an increase in the number of varieties can cause an increase (decrease) in world consumption.