Supply side model
This section defines technology level as the unit of labor required to produce a unit of homogeneous good. It is assumed that homogeneous external goods are produced jointly by both countries and are freely traded between them, so the wage in both countries can be normalized as 1. Since the production of heterogeneous final goods requires a package of intermediate inputs, and all firms need to pay additional costs when undertaking the production and development of a new product, firms need higher production costs to produce heterogeneous final goods; meanwhile, it is assumed here that their subsequent production will generate incremental returns to scale.
Although a firm may produce multiple heterogeneous products, each of them can produce only one core product. The production of the core product corresponds to the core competitiveness of the company and is related to the core productivity ф of the company. To obtain this core productivity, a firm must first pay a cost fe to enter the market. The model assumes that each firm’s core productivity is randomly drawn from its known productivity distribution C7(>), and the range of ф is °°).
Source of intermediate inputs and marginal costs
afv, ф) represents the units of labor needed by country j(j e [#, F]) to produce a unit of intermediate good v(v e [0, 1])
where rfa represents the trade cost of Country / importing intermediate goods from the country of origin Л (v). When Л (v) * /, r,f = 1, and r/f(v)/ > l.5
Referring to the study by Eaton and Kortum (2002), it is assumed that the efficiency distribution in the production of intermediate goods in a country follows the following Frechet distribution.
where 7), > 0, and this parameter determines the technology level of Country /;. 0 determines the variation in the selected productivity level. Thus, marginal cost ф of the final good produced by Country / is required to satisfy
where 0/ = 7} + 77, (rj))~9 represents the ability of enterprises in Country / to obtain intermediate goods, f - [Г(9 + ^~p]g/( 1 ~p), and Г represents Gamma function.