Using Home-Biased Demand to Test Trade Theories

This paper proposes a discriminating hypothesis that distinguishes between two paradigms of international trade: (1) constant returns and perfect competition (CRS-PC) and (2) increasing returns and monopolistic competition (IRS-MC). The discriminating hypothesis rests on the different degree of home bias among "consumers." It predicts a positive relationship between a country's share in world output and a country's share in the world homebiased expenditure if the sector is IRS-MC and no relationship if the sector is CRS-PC. Accordingly, 7 sectors (covering 54.86 per cent of industrial output) of the eight countries under investigation were associated with the IRS-MC and 10 sectors (41.15 per cent) with the CRS-PC paradigm.