type I extreme value distribution. Following Eaton and Kortum (2002), we assume that the prices of intermediate goods have Frchet distribution as follows: (9) is the fraction of intermediates for which country i’s price is below p, is a location parameter specific to a country and an industry expressed as (10) The lowest price for an intermediate good in country n is less than p unless each source country’s price is greater than p. As in Eaton and Kortum (2002), a higher implies a higher average productivity of a sector k in country i governing country i’s absolute advantage while the parameter refers to the inverse of productivity dispersion across goods reflecting the comparative advantage. The larger is , the smaller the dispersion of productivity and the higher the probability that country n buys intermediate good in industry k from the country with relatively low costs. The distribution of the lowest price of an intermediate good in country n is Let the of intermediate good exported from country i to country n is denoted by . Also, let the probability that country i produces an intermediate good in industry k at the lowest price in country n is . Then, this probability becomes the country n’s share of expenditure on intermediate goods from i at sector k which is presented as (11) It is shown that the bilateral trade share is decreasing in i’s relative production cost and trade cost while it is increasing in relative productivity. We the model by assuming that factor market clears. Total factor payments across goods is equal to factor income. = (12) 3. Empirical Specification
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