Import Penetration and Consumption of Domestic and Foreign Varieties

Abstract

This paper analyses import penetration with a consumer demand approach that distinguishes domestically and foreign-produced varieties. Consistent aggregation leads to a macro-level import demand equation that faithfully reflects the underlying micro demands for foreign varieties. The approach avoids restrictive assumptions such as homotheticity and permits an array of hypothesis tests of functional form. We show how to estimate the model with a relative short time series-important for countries with limited data-and as an illustrative example, apply it to Australia. We find that income growth is largely responsible for the recent surge in imports into that country.