World Development Vol. 40, No. 4, pp.
808–820, 2012
www.elsevier.com/locate/worlddev
doi:10.1016/j.worlddev.2011.09.021
Consumers’ Welfare and Trade Liberalization: Evidence
from the Car Industry in Colombia
JORGE TOVAR *
Universidad de los Andes, Bogotá, Colombia
Summary. — This paper examines the effects of tariff removal on consumers’ welfare focusing on the Colombian trade liberalization
process and its automobile industry. Using product level data this paper calculates the post-reform gains in consumers’ welfare to be
just below three thousand dollars per purchaser. Counterfactual simulations suggest that the gains achieved are due, for the most part,
to increased variety rather than to price competition.
Ó 2011 Elsevier Ltd. All rights reserved.
Key words — trade liberalization, trade reforms, consumer surplus, automobiles, Latin America, Colombia
1. INTRODUCTION
Trade theory predicts that intensified international competi-
tion leads to efficiency gains on consumers’ welfare. 1 How-
ever, an overview of the existing empirical literature suggests
that although such gains may actually exist, it has rarely been
explicitly quantified. In fact, in a survey on the topic, Tybout
(2003) concludes that the expected benefits of free trade on
consumers have been for the most part inferred from the re-
sults, not directly measured. 2 This paper contributes in filling
such a gap by quantifying consumers’ gains from a trade lib-
eralization process in the context of an oligopolistic market
with differentiated products.
The Colombian case offers an excellent opportunity to study
such effects given the way the reforms were implemented. The
trade reform was initially planned in the last quarter of 1990
and scheduled to be gradually implemented over a four-year
period. However, by the second half of 1991, policy makers
did not observe the projected effects and decided to immedi-
ately (and unexpectedly) reduce tariffs to the levels expected
in 1994. This unique feature, the fact that prior to 1992 no for-
eign cars were available and that the number of domestic firms
remained constant over the entire sample period, allows for
the analysis of the effects of the liberalization process free of
possible restrictive trade endogeneity issues.
The expected correlation between trade reforms and con-
sumers’ welfare is tested using a discrete choice model, an ap-
proach widely used in the industrial organization literature to
estimate welfare effects in given markets but relatively uncom-
mon when exploring international trade issues. 3 These models
are powerful in that they allow the researcher to quantify the
consumers’ surplus given an exogenous shock. For instance, in
an early application to international trade, Berry, Grilli, and
López de Silanes (1992) forecast the expected growth of the
Mexican car industry in an attempt to anticipate the effects
of NAFTA. They conclude that economic growth joint with
a decline in prices toward international levels would expand
the Mexican auto market.
The closest methodological applications to mine are those
found in Fershtman and Gandal (1998), Brambilla (2007)
and Clerides (2008). As I do, they study and quantify the effect
of trade related shocks on consumers’ welfare. They differ in
the specific empirical model used and the trade shock studied.
Fershtman and Gandal (1998) estimate that the end of the
808
Ó 2011 Elsevier Ltd. All rights reserved
0305-750X/$ - see front matter
Arab boycott on the Israeli car industry led to a “per-pur-
chaser gain of approximately US$2,243”. Brambilla (2007)
measures the effect of adopting a customs union in the auto-
mobile market in Argentina and Brazil. She finds that under
a customs union, prices in Argentina will be lower, while
consumers would be better off. The opposite is true for Brazil.
Clerides (2008) reports average consumers’ gains of US$2.000
per purchaser when used cars were authorized to massively
enter the Cyprian market. 4
In the Colombian case, I focus on the automobile market
and, using data prior and after the 1990s trade reforms, quan-
tify the effects of such reforms on consumerś surplus taking
into account the effects of foreign competition. Specifically,
using prices, characteristics, and car sales in Colombia be-
tween 1986 and 1998, a discrete choice random utility model
is adopted to econometrically estimate demand. 5 A GMM
framework deals with the potential correlation between prices
and unobserved car characteristics enabling consistent de-
mand estimates. These estimates are then used to compute
the consumer surplus over the thirteen year period. Theory
predicts that lower tariffs and stronger competition should
positively impact on consumers’ surplus. The source of such
gains is originated in the associated increase in the number
of product varieties generated by the trade reform. Indeed evi-
dence of this is found. The increased variety and lower car
prices improved consumers’ welfare by almost three thousand
* This paper is part of my Ph.D. dissertation in economics at the
University of California, Berkeley. I wish to thank my advisor Aviv Nevo
and my dissertation committee members Aaron Edlin and Ann Harrison
for their suggestions, support, and helpful discussion. I also wish to thank
Richard Gilbert, Rebecca Hellerstein, Maurice Obstfeld, Sofia Berto
Villas-Boas, the editor, two anonymous referees, and participants in the
Industrial Organization and International Trade Seminars at UC Berkeley
for helpful comments. Financial support from Colombia’s Central Bank,
Banco de la República fellowship for Graduate Studies in Economics
Abroad, the UC Berkeley Summer Fellowship and Dean’s Fellowship is
gratefully acknowledged. I am also grateful with Ann Harrison’s private
research account in the Agricultural and Resource Economics Department
for funding my visit to Colombian Auto Firms. Finally, I am indebted to
the Center of Latin American Studies at Stanford University for its
hospitality while working on the revised version of the paper. All errors
are my own. Final revision accepted: August 12, 2011.
 CONSUMERS’ WELFARE AND TRADE LIBERALIZATION
dollars per purchaser compared to the pre-reform period.
Counterfactual simulations suggest that such gains are mostly
explained by the increased number of car models available in
the market once the reform was implemented.
Although extremely useful in its ability to quantify the effect
of a major trade reform on consumers’ welfare, the use of
product level data comes at a cost. 6 The literature on the ef-
fects of trade on growth, productivity, and welfare can be di-
vided into three general categories: Cross country regressions,
cross industry regressions, and product level analysis. 7 The
latter has no saying in productivity, growth, or labor realloca-
tions, especially given the characteristics of the car industry in
Colombia (discussed later in Section 2).
The remainder of the paper is organized as follows. Section
2 describes the Colombian trade liberalization process and
presents the specifics of its auto industry. Section 3 lays out
the demand and supply model. Section 4 describes the data
while Section 5 discusses the estimation strategy. Section 6 re-
ports and discusses the results. Finally Section 7 concludes.
2. TRADE REFORM AND THE CAR INDUSTRY
IN COLOMBIA
Following international trends, many Latin American coun-
tries undertook international policy changes in the early 1980s.
In Colombia, however, although some very timid liberaliza-
tion measures were taken at the time, it was not until 1991
when deep structural fiscal, labor, monetary, and trade re-
forms were actually implemented. 8 Previously, high tariffs
and various types of nontariff barriers prevailed in all sectors
of the economy making imported products scarce and expen-
sive to buy. By 1989, the outgoing government took initial
steps to open the economy, but different internal and external
events prevented any serious reforms from being implemented.
Therefore, it was not until 1990, when the recently elected
Gaviria Administration designed a four-year program to grad-
ually lower tariffs. In October 1991 the gradual program was
terminated and Colombian policy makers decided to abruptly
lower tariffs, breaking the program designed months earlier. 9
Tariffs were set, in the last quarter of 1991–94 expected levels.
Among other reasons, the stagnation of both imports and ex-
ports induced government analysts to believe that economic
agents were postponing any investment decision until the mo-
ment when tariffs were at their lowest levels. Once tariffs were
taken down they did not vary substantially.
During the sample period (1986–98) three companies were
the sole assemblers (not producers) of cars in Colombia. The
three companies are Compañı́a Colombiana Automotriz
(CCA), assembler of Mazda; Sociedad de Fabricación de Auto-
motores S.A. (Sofasa), assembler of Renault and General Mo-
tors Colmotores S.A. (GM Colmotores), assembler of General
Motor vehicles.
The oldest and historically largest firm, Colmotores, was
founded in 1956. As part of GM, the company assembles
and sells in Colombia Chevrolet’s, Opel’s, and Suzuki’s mod-
els under the Chevrolet make. CCA, the second oldest firm,
was founded in 1960. Fiat models were produced until 1983
when the company was authorized to switch to Mazda’s. By
1993, the entire company was owned by Mazda. Sofasa was
established in the late 1960’s with the creation of a joint society
between the Colombia Government and Renault. By the end
of the sample period the company was owned by Renault,
Toyota, and Mitsui. 10 Therefore, prior to 1991 no imported
cars were sold massively in Colombia. Although it was legal
to import cars, barriers such as high tariffs, import license
809
requirements, and a series of taxes required when “nationaliz-
ing” the car made it impossible in practice.
Given that domestic firms assemble but do not produce cars
in Colombia, most of its inputs are imported. The imported
materials known as CKD, which stands for Completely
Knocked Down, represent around 70% of a fully assembled
car. Throughout the period of analysis (1986–98) the main reg-
ulation changes were related to the 1991 structural reforms.
Prior to the reforms, the government intervention in the car
market began to be relaxed, particularly in the second half
of the 1980’s. Among other things, for example, a new con-
tract unifying the operational conditions of all three firms in
the market was signed in 1988.
In 1991, as part of the reforms, the government authorized
the entry of new firms willing to assemble cars, it eliminated
the import license requirements for CKD units and reduced
the tariffs for both CKD and imported or completely built up
(CBU) cars. Firms were allowed to freely assemble as many
models and versions as they wanted, as long as they guaran-
teed the supply of auto parts and service for each model for
a period of at least 10 years. However, even today, there are
only three firms assembling cars, the rest are simply importers
of ready to sell vehicles. Moreover, as in the 1980s, once the
reform was implemented, each of the Colombia firms retained
its only assembly plant. Thus, the trade reform had no effect
on plant closings or, for that matter, on layoffs at a significant
scale.
3. THE MODEL
The use of disaggregated data offers several advantages.
First, physical output is observed as opposed to revenue, typ-
ically used when using industry (or plant) level data. Second,
competition is not inferred, but directly observed as imported
cars entered the market. Third, the approach is powerful en-
ough to fulfill the main objective of the paper: estimate the ex-
pected gains in consumers’ welfare due to the trade
liberalization process. 11
(a) Demand model
The demand model described here is derived from McFad-
den’s (1978) generalized extreme value model (GEV) as devel-
oped by Bresnahan et al. (1997). The product differentiation
general extreme value (PD GEV) model allocates each alterna-
tive to one nest along each of pre-selected dimensions. It is
based on the notion that markets for differentiated products
exhibit increased cross-elasticity due to nesting relative to
dimensions. This paper differentiates characteristics along
two dimensions: origin (domestic vs. foreign) and size as per-
ceived by engine displacement (small, medium, large).
The most commonly used version of GEV models is the
nested logit. Motivated by different questions, Goldberg
(1995) and Goldberg and Verboven (2001) use a multi-level
and a two-level nested logit, respectively, to estimate demand
for cars. 12 Similarly, also for cars, Berry, Levinsohn, and
Pakes (1995), Berry, Levinsohn, and Pakes (1999), Petrin
(2002) and Brambilla (2007) use a random coefficient logit ap-
proach to determine demand estimates.
The main advantage of the PD GEV model over the nested
logit model is that while in the latter the order of the nests
matters, in the former it does not. The nested logit model im-
plies that all alternatives are grouped into pre-determined
mutually exclusive nests. This means that given two categories,
origin and size, a change in price on say, a small Colombian
810
car, will have the same effect on shares on a medium Colom-
bian car and over a large Colombian car. The PD GEV over-
comes this limitation.
In principle, the random coefficient logit model allows for
flexible substitution patterns without a priori segmenting the
market. As argued by Nevo (2000), this advantage comes at
a cost. First, the expression for the share function is solved
via simulation as opposed to the close form of the PD
GEV model. Second, detailed information about consumer
heterogeneity is required to compute the market shares.
Third, Petrin (2002) notes that a very rich dataset set is re-
quired in order to obtain precise estimates. Given the limita-
tions of the dataset, only 926 observations and no consumer
heterogeneity available beyond income, I choose to use the
PD GEV model.
The model used is relatively standard in the literature. 13 As-
sume that the conditional indirect utility function for con-
sumer i for product j in market (period) t depends on
observed product characteristics (xjt), unobserved (to the re-
searcher) product characteristics (njt), income (yit), price (pjt),
and unknown parameters hjt. Building on a Cobb Douglas
utility function, Berry et al. (1995) showed that the following
functional form may be used to study the consumers’ decision
problem:
U ijt  a lnðy it  pjt Þ þ xjt b þ njt þ eijt
djt ¼ xjt b þ njt
i ¼ 1 . . . I; j ¼ 1 . . . J ; t ¼ 1 . . . T
where eijt is defined below. Note that yit, as in Berry et al.
(1995) and Goldberg and Verboven (2001) among others, is
individual specific. The way how this is dealt with is discussed
below.
The djt term is common to all consumers and is, therefore,
referred to as the mean utility, a is the marginal utility from
income and b represents specific taste characteristics. Correla-
tion between the price and the unobserved product character-
istics is expected because when the price is set, the producer
takes into account these (observed by the firm) characteristics.
When estimating the model, this endogeneity issue will be ta-
ken into consideration. As discussed in detail in Appendix 1,
eV ij Gj ðeV io ; . . . ; eV iJ Þ
S ij ¼
GðeV io ; . . . ; eV iJ Þ
is the market share equation of product j, where Vij = aln(yi
 pj) + dj and Gj is the partial derivative of G with respect
to eVij. G(.) is defined as the weighted sum of two one-level
nested multinomial logit G(.) functions:
" !qO !qO #
X X
Vi V ij =qO V ij =qO
Gðe Þ ¼ aO e þ e cise it is necessary to derive an equilibrium condition.
j2d j2f
" !qS
X X
þ aS e V ij =qS
þ e
j2s j2m
!qS #
X
V ij =qS
þ e þ eV i;outside
j2l
ð1  qO Þ ð1  qS Þ
aO ¼ ; aS ¼
ð2  qO  qS Þ ð2  qO  qS Þ
where O denotes origin (domestic (d) or foreign (f)) and S
stands for size (small (s), medium (m) or large (l)). Under
WORLD DEVELOPMENT
the conditions stated in Appendix 1, the model is consistent
with random utility maximization for all possible values of
the explanatory variables as long as qO and qS lie in the unit
interval. 14
Letting O(j) and S(j) denote the groups to which product j
belongs, and using G(.) from Eqn. (2), the following share
equation is derived:
P P
aO eV ij =qo ð k2OðjÞ eV ik =qo Þqo 1 þ aS eV ij =qs ð k2SðjÞ eV ik =qs Þqs 1
sij ¼
GðeV i Þ
ð3Þ
Eqn. (3) is the probability that consumer i buys car j and is
composed of two terms, one for origin and one for size. It im-
plies that for any car j, a change in the price or characteristics
of any other product located in the same cluster will have a
stronger impact on product j than on any other product lo-
cated in a different cluster. The parameter q is a measure of
the degree of independence in unobserved utility among the
products in nest n. That is, as q tends to zero, the dependence
across products that share a particular nest become stronger.
Conversely, if qs = 1, the model reduces to a nested logit by
origin status only. Similarly if qo = 1, the model reduces to
a nested logit by size status only. Eqn. (3) is the close form
solution to the integral presented in Eqn. (A.1).
Finally, the expression for Sij has to be aggregated up to
ð1Þ the product market share function. While aggregating in-
come and population data available for Colombia are used.
Ten equally sized deciles are defined and the per capita in-
come of consumers within each income class is computed,
that is income is ‘common’ within each decile, but varies
across deciles and, of course, over time. This approach
resembles that of Goldberg and Verboven (2001). That is,
Eqn. (3) is calculated for the average consumer in each in-
come class and the summation generates the aggregate mar-
ket share.
(a) The supply side
The effect of the trade reform on consumers’ welfare can be
directly estimated by comparing the post-reform welfare with
the pre-reform welfare. Given the way that trade liberalization
was implemented in Colombia, this seems like a valid way to
calculate the (expected) positive effects. However, a simple
comparison between periods simultaneously captures both
the price and variety effects. In order to disentangle these ef-
fects the following question should be answered: how much
would have consumers’ welfare changed if no imported cars
had entered the market?
The counterfactual exercise is described in detail later on.
For now, note that in order to be able to perform such an exer-
Assume that in any given year t, there are F firms, each of
!qS which produces some subset Jf, of the j = 1. . .J different makes
V ij =qS of cars. The firms profit function is given by
X
pf ¼ ðpj  mcj ÞMsj ðpÞ  C f
Jf
ð2Þ
where mcj is the marginal cost, Cj is the fixed cost of produc-
tion and M is the total market size. 15 The standard derivation,
presented in Appendix 2, yields in matrix notation:
ðp  mcÞ ¼ X1 sðpÞ ð4Þ
where as is common in the literature, X is defined as the own-
ership matrix 16.
 CONSUMERS’ WELFARE AND TRADE LIBERALIZATION 811

Table 1. Summary statistics means (sales weighted) (standard deviation in parenthesis)

No. of Models Pricea HP/Wb Engine Dimensiond ACe Power windowse Power door lockse Radioe Alloy wheelse
displacementc
1986 18 22,988 0.078 1.516 6.836 0.091 0.152 0.093 0.107 0.034
(6,571) (0.013) (0.337) (0.874) (0.296) (0.369) (0.299) (0.318) (0.185)
1987 23 25,082 0.079 1.508 6.831 0.177 0.243 0.267 0.268 0.132
(7’,967) (0.011) (0.377) (0.910) (0.389) (0.438) (0.452) (0.452) (0.345)
1988 19 23,522 0.078 1.459 6.652 0.275 0.416 0.242 0.224 0.137
(8,073) (0.013) (0.382) (0.989) (0.458) (0.506) (0.440) (0.428) (0.353)
1989 21 21,111 0.078 1.462 6.675 0.281 0.406 0.205 0.326 0.122
(6,801) (0.013) (0.365) (0.976) (0.460) (0.503) (0.413) (0.480) (0.334)
1990 27 20,815 0.079 1.473 6.718 0.212 0.390 0.319 0.354 0.150
(6,756) (0.012) (0.358) (0.911) (0.416) (0.496) (0.474) (0.487) (0.363)
1991 26 18,434 0.080 1.464 6.663 0.195 0.298 0.272 0.329 0.134
(6,349) (0.009) (0.333) (0.880) (0.404) (0.466) (0.453) (0.479) (0.347)
1992 71 19,415 0.082 1.508 6.889 0.289 0.325 0.238 0.360 0.363
(10,185) (0.013) (0.345) (0.722) (0.456) (0.471) (0.429) (0.483) (0.484)
1993 82 19,922 0.083 1.509 6.941 0.294 0.406 0.282 0.433 0.333
(9,778) (0.014) (0.353) (0.723) (0.458) (0.494) (0.453) (0.498) (0.474)
1994 122 18,679 0.082 1.447 6.823 0.308 0.367 0.282 0.447 0.401
(7,876) (0.0129) (0.317) (0.719) (0.463) (0.483) (0.452) (0.499) (0.492)
1995 127 17,986 0.081 1.425 6.736 0.276 0.348 0.287 0.401 0.492
(7,730) (0.013) (0.295) (0.671) (0.449) (0.478) (0.454) (0.492) (0.501)
1996 133 16,533 0.081 1.386 6.601 0.299 0.265 0.230 0.403 0.466
(7,083) (0.0123) (0.262) (0.664) (0.460) (0.442) (0.422) (0.492) (0.500)
1997 142 15,897 0.083 1.386 6.591 0.188 0.240 0.237 0.472 0.427
(6,379) (0.012) (0.239) (0.674) (0.392) (0.428) (0.426) (0.501) (0.496)
1998 115 14,444 0.086 1.418 6.653 0.328 0.274 0.227 0.547 0.463
(6,341) (0.012) (0.246) (0.709) (0.471) (0.448) (0.421) (0.500) (0.501)
1986–98 926 18,862 0.082 1.448 6.735 0.259 0.318 0.249 0.390 0.335
(8131) (0.013) (0.314) (0.771) (0.438) (0.465) (0.433) (0.488) (0.472)
1986–91 22 22,300 0.079 1.480 6.729 0.205 0.317 0.233 0.268 0.118
1992–98 113 17,437 0.083 1.440 6.748 0.283 0.318 0.255 0.437 0.421
a
Price in 1996 dollars.
b
HP/W: measured in Horse Power (HP) per Weight (in kilograms).
c
Engine displacement measured in cubic liters.
d
Dimension is width*length. Square meters.
e
Indicator variables, 1 if it has the characteristic as standard equipment, 0 otherwise.

4. DATA DESCRIPTION AND PRELIMINARY
RESULTS
The dataset contains information on prices and characteris-
tics per model sold in Colombia during 1986–98. Indicator
variables for whether the car has air conditioning (AC), power
windows, power mirrors, power seats, alloy wheels, power
door locks, assisted steering wheel, and radio as standard
equipment were obtained from Motor magazine. 17 Other
product characteristics, obtained from each models brochure
going back to 1986, include the car dimensions (length, width,
and height), weight, engine displacement, horsepower, and the
number of doors.
The price variable is the list price as shown in several issues
of the Colombian Motor auto magazine. All prices are deflated
by the consumer price index and are in 1996 Colombian pesos,
though the results, for ease of comparison, are presented in
1996 US dollars. The sales variable corresponds to sales in
Colombia.
The estimations presented below use only the available data
on automobiles, by far, the most common type of vehicle sold
in Colombia. Prior to 1992, SUV’s and pickups sales repre-
sented on average less than 20% of the market. Once the re-
forms were implemented, the sales share of automobiles was
never below 70%. 18
As a principle of differentiation, rather than using the cars
dimensions (as used for example by Goldberg, 1995), I choose
engine displacement as measured by cubic centimeters (CC).
My choice is based on the fact that automobiles are legally
classified in Colombia according to CC, among other things,
for insurance purposes. Additionally, consumers perceive
many models differently, despite sharing the same chassis
and body, because they are equipped with different engines.
Such vehicles have the same dimension, they look alike, but
they actually belong to a different segment.
During the sample period six hundred thousand cars were
sold. It was possible to match price, quantity and characteris-
tics to most of the cars in the dataset. However, it was not pos-
sible to identify 24,406 cars because they show up as others in
the quantity dataset. Following Berry et al. (1995) a model/
year is treated as an observation. This results in a total sample
size of 936 observations. Additionally, no price information
was available for ten observations, and so the final sample size
is composed of 926 observations.
In addition, there are data available on tariffs, the value
added tax of each model and a real exchange rate index. 19
Tariffs vary by country of origin and engine displacement.
For a completely built up (CBU) car the corresponding tariff
is that of a fully assembled, ready-to-sell vehicle. These are
imported cars. For a domestically assembled car the tariff
 812
Table 2. Summary statistics (sales weighted)
(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix)
Pricea CKD (input) CBU (imported car) Tariffs Sales Real exchange Number of Market Shared Number of
tariffsb tariffsc tax rate index Models Offered Cars Sold
Domestic Foreign Small Medium Large Domestic Small Medium Large Total Domestic Foreign
1986 22,988 19.94 200.00 19.94 26.55 113.96 18 – 5 8 5 100.00 31.28 46.47 22.25 29,150 29,150 –
1987 25,082 20.66 200.00 20.66 26.86 114.77 23 – 6 10 7 100.00 43.62 30.11 26.27 34,277 34,277 –
1988 23,522 19.52 200.00 19.52 25.95 113.78 19 – 6 6 7 100.00 47.54 27.04 25.42 36,775 36,775 –

WORLD DEVELOPMENT
1989 21,111 20.24 218.00 20.24 26.88 120.60 21 – 6 8 7 100.00 47.68 30.07 22.25 30,471 30,471 –
1990 20,815 20.53 116.00 20.53 27.35 130.99 27 – 7 11 9 100.00 48.47 28.79 22.74 25,786 25,786 –
1991 18,434 19.45 75.00 19.45 26.45 114.75 26 – 7 11 8 100.00 45.14 34.04 20.82 22,206 22,206 –
1992 19,415 3.00 38.83 13.20 28.50 108.71 27 44 13 28 30 71.53 44.36 36.09 19.55 34,230 24,485 9,745
1993 19,922 3.00 38.12 18.38 28.80 110.29 23 59 14 36 32 56.22 42.60 39.89 17.51 62,324 35,037 27,287
1994 18,679 3.00 35.00 15.92 27.16 102.87 25 97 21 63 38 59.62 52.66 35.10 12.24 72,452 43,199 29,253
1995 17,986 3.00 35.00 14.96 26.48 104.46 28 99 26 67 34 62.64 56.67 35.00 8.33 66,191 41,462 24,729
1996 16,533 3.00 35.00 14.21 26.28 100.00 36 97 30 71 32 64.97 64.98 30.82 4.21 61,442 39,921 21,521
1997 15,897 3.00 34.64 18.12 27.12 92.77 32 110 37 81 24 52.01 53.62 44.04 2.34 74,687 38,999 35,688
1998 14,444 3.00 34.83 19.53 27.81 100.99 25 90 29 74 12 48.07 39.01 57.27 3.73 59,643 28,670 30,973
1986–91 22,300 20.06 168.17 20.06 26.67 118.14 22 – 6 9 7 100.00 43.96 32.75 23.29 29,778 29,778 –
1992–98 17,437 3.00 35.92 16.33 27.45 102.87 28 85 24 60 29 59.29 50.56 39.74 9.70 61,567 35,968 25,599
1986–98 24.74 10.87 96.96 18.05 27.09 109.92 25 85 16 36 19 78.08 47.51 36.52 15.97 46,895 33,111 25,599
a
Price in 1996 US dollar.
b
Tariffs for the CKD units used by domestic producers (%).
c
Tariff for imported cars (%).
d
As defined by total sales.

Table 3. Summary statistics
Variable Mean Std. Dev.
Sales tax 32.41
Real exchange rate index 109.21
Tariffsa 26.82
CKD tariffsb 11.05
Assembled car tariffsc 58.69
a
If domestic car, CKD tariffs. If imported car CBU tariffs.
b
Tariffs for main components of domestically assembled cars (the CKD
unit).
c
Tariffs for imported cars (CBU).
corresponds to that of its main input, the completely knock
down or CKD units.
Tables 1–3 provide summary statistics for the key variables.
Table 1 presents information on the main characteristics.
These include horsepower per kilogram (HP/W), dimension,
AC, power windows, power door locks, radio, engine displace-
ment, and alloy wheels. HP/W proxies for fuel efficiency as
well as for power; it is expected to affect positively the utility
of a consumer. Dimension is defined as length times width.
The effect is not clear, though one tends to believe that on
average individuals prefer bigger cars. Finally, engine
displacement is measured in liters and the indicator variables
(1 if standard equipment, 0 if not) show how, on average,
characteristics have changed over time.
This first overview of the data clearly illustrates the struc-
tural changes observed in the market once the reforms took
place. Both Table 1 and Figure 1 show significant changes be-
tween the pre-reform (1986–91) and the post-reform period
(1992–98). On average, 22 models were offered during 1986–
91. By 1992, 71 different car models were offered, peaking
142 in 1997.
Table 2 (column vi) shows that the number of domestic mod-
els increased moderately despite foreign competition. In fact,
during the early years of the reforms, the number of models of-
fered by domestic firms fell to levels similar to those observed in
the period 1986–89. This contrasts with the overall increase in
variety. That is, the addition of new models exceeds the number
of drop outs. This could potentially be explained by stronger
product-market competition and the expansion of the potential
market due to lower prices. It could be argued that this behav-
ior follows the predictions suggested, at least, since Krugman
(1980): a reduction in the number of models offered by domes-
26.000
24.000
22.000
Prices (1996 dollars)
20.000
18.000
16.000
14.000
12.000
10.000
1986
Price (Left Axis)
CONSUMERS’ WELFARE AND TRADE LIBERALIZATION 813
tic firms despite an increase in overall variety. If such is the
Min. Max. case, an increase in consumers’ surplus should be expected.
One could even try to push the argument a little further: fol-
7.33 20 45 lowing the predictions of recent trade models domestic firms
23.78 8.75 187.89
are dropping their least successful models (Bernard, Redding,
13.48 3 40
& Schott, 2011). However, it would be necessary to further
10.86 3 30
explore the models predictions in detail such as within firm
54.27 31.5 218
composition changes and, even then, nothing can be said in
terms of exports given that during the sample period domestic
firms did not enter foreign markets. 20
The data also show that prices in Colombia, in the 1980’s,
were abnormally high for international standards. In 1986
the mean price of a car was, in 1996 US dollars, almost
$23,000 while the average price for a car in the United States
at the time was around $18,000. 21 By 1992, average prices in
Colombia were over nineteen thousand dollars, approximately
a thousand dollars higher than in the US. At the end of the
sample period, on average a car could be bought in the US
paying just over nineteen thousand dollars. In Colombia, that
year, the average price of a car was less than fifteen thousand
dollars (See Figure 1). 22
As shown in Fig. 2, even when adjusting for quality, prices
fell significantly by 1992. In fact, when comparing the pre-
reform (1986–91) and the post-reform (1992–98) periods, qual-
ity-unadjusted prices fell on average by 22% (column (i), Table
2), while quality-adjusted prices dropped on average by 42%.
The quality adjusted trend is similar when considering the
two principles of differentiation. 23
Immediately after the trade reforms were implemented, the
number of cars sold increased. The 50% annual average
growth rate observed during 1992–94 contrasts with the en-
tire’s sample period 10% average growth rate. As imports in-
creased, the market share of domestic firms dropped. On
average, importers gained in seven years over 40% of the car
market in Colombia.
A closer look at the data reveals that the number of domes-
tic cars sold expanded with the reforms for a short period of
time (Figure 1). Sales of domestically produced cars increased
from an average of less than thirty thousand cars per year
prior to the reforms to a peak of forty three thousand in
1994. Since then, sales of domestically assembled cars steadily
dropped. By 1998, only 28,670 domestically assembled cars
were sold, less than in 1986.
Table 2 also shows the evolution of tariffs during the sample
period. As noted earlier, both the CBU and CKD units’ tariffs
Evolution of Prices and Units Sold
1986-1998
80000
70000
60000
50000
Units Sold
40000
30000
20000
10000
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Total Units Sold (Right Axis) Total Colombian cars sold (Right Axis)
Figure 1. Evolution of prices and units sold 1986–98.
814 WORLD DEVELOPMENT

Quality adjusted price

1986=1

1.4
1.2
Ïndex
1
.8
.6

87 88 89 90 91 92 93 94 95 96 97 98
Source: Author's calculations Year
Dotted lines are 95% confidence interval.

Figure 2. Quality adjusted price 1986=1.

fell substantially. The former dropped from an average of A second set of instruments is based on Bresnahan (1981,
200% in 1986 to 34% in 1998. The latter dropped to 3% from 1987) assumption that the observed characteristics xjt
an average of almost 20%. As noted earlier, such high tariffs are exogenous (or predetermined) and thus uncorrelated
were key in explaining why no foreign cars were imported with the unobserved characteristics, therefore, satisfying
prior to 1992. Eqn. (A.4). 26 Bresnahan et al. (1997) follow a similar
approach, but exploit their assumption about the group struc-
ture of product differentiation.
5. ESTIMATION OF THE MODEL Therefore, this second set of instruments is based on the idea
of the exogeneity of observed product characteristics and of
The predicted market share derived in Eqn. (3), analytically the number of models available in the market per period.
obtained by solving the integral in Eqn. (A.1), is a function of These are the average value of the characteristics by cluster
observed and unobserved product characteristics, as well as (origin and size) and by shared cluster. The total number of
prices (details are provided in Appendix 3). cars sold per cluster is also used. The latter are competition
The estimation of Eqn. (A.5) requires instrumental variables based instruments in that they assume that the number of cars
that satisfy Eqn. (A.4). The ideal instruments would be (mod- available in the market each year is correlated with prices but
el-level) cost data. However, beyond the average cost of not with unobserved characteristics. These guarantee instru-
assembling a car for each of the three domestic firms there ment variation at the product level.
was no access to direct cost data. This would be a valid, It should be noted that instruments based on nonprice char-
though insufficient instrument if the objective were to estimate acteristics of competing products are, potentially, problematic.
demand exclusively prior to 1992 when only domestic produc- However, as noted by Einav and Levin (2010) so is the main
ers served the market. 24 alternative used in the literature, the use of prices in other mar-
Fortunately, some cost related data are available. Given kets. 27 The intuition behind the use of the price of a car in
that (after 1991) imported cars represent a significant share alternatives markets as a valid instrument is that such price
of total sales and that the main inputs of domestically pro-
duced cars are also imported both a real exchange rate index
and import tariffs are used as instruments. Table 4. Demand estimates
The advantage of using exchange rates and tariffs as instru-
ments is that they are clearly exogenous to the car industry PD GEV estimate (S.E)
and that they both exhibit variation over time and across a 4.381 (1.504)**
car segments. These instruments are not model specific, but qo 0.619 (0.203)***
they differ across segments generating the necessary within qs 0.483 (0.279)*
year variation. Tariffs vary by (i) country of origin (CKD Domestic 0.708 (0.193)***
for domestic cars, CBU for imported cars) and by the (ii) en- Small 0.886 (0.153)***
gine displacement of the car, that is larger cars pay larger tar- Medium 0.363 (0.092)***
iffs. Dimension 1.257 (0.568)**
Similarly, the exchange rate varies per country of origin and HP/W 3.789 (2.314)*
over time. 25 The sales tax, also used as an instrument, varies AC 0.015 (0.071)
too by engine displacement and over time. It has the same Pwr Windows 0.159 (0.082)*
advantages and disadvantages of the aforementioned. Thus, Constant 19.491 (5.200)***
given the way the instruments are constructed, it is possible GMM 31.550
to include year time effects in the estimation in order to cap- Robust standard errors in parenthesis.
ture any industry-level shocks that might have occurred during *
Significant at 10% level.
**
the sample period. These instruments, however, are not suffi- Significant at 5% level.
***
cient for identification. Significant at 1% level.
 CONSUMERS’ WELFARE AND TRADE LIBERALIZATION
is driven by the underlying costs. Thus, they are a valid proxy
for unobservable model/year specific costs. 28
This approach is not feasible in the current context and, fur-
ther, it does not guarantee a better cost proxy. There are seri-
ous operational shortcomings when trying to match the price
of each model/year price in the dataset with a corresponding
match in other markets. First, prices would have to be gath-
ered from various alternative countries because not all cars
were sold simultaneously in all markets during the sample per-
iod. This is problematic because to make prices comparable
across markets (countries), exchange rates for every country
would need to be used. But exchange rates are, at least par-
tially, driven by macroeconomic events specific to each coun-
try which empirically are not possible to control for. But, even
if it were possible to control for, the mere existence of unob-
served shocks in other markets would violate the original
assumption: prices in other markets would not be a valid
proxy for costs.
A second operational shortcoming is related to the quality
of the price data available in different countries. Typically,
only list prices are available. But these may (as in many
Europeans countries for instance) or may not (as in the
USA) include the sales tax (or any other tax for that matter).
Identifying this in a large number of countries during a period
of 13 years can be extremely burdensome. Lastly, there is an
availability issue. The data used in this paper go back to
1986; matching this historical data was not possible for such
a long period of time.
Another potential alternative could be the use of price cost
margins in other markets. This was not feasible because of the
lack of correspondence between Colombian models/years and
those estimated by the literature (Brambilla, 2007, Berry,
Levinsohn, and Pakes, 1999 or Goldberg & Verboven, 2001
among others). 29 Moreover, most of the literature estimated
these PCM using as instruments either of the above methods.
In such a case we would be back to square one.
6. RESULTS
The results of the PD GEV model are presented in Table 4.
The coefficients are precisely estimated and appear to be rea-
sonable from an economic point of view. The results suggest
that individuals prefer bigger cars as well as high horse power
relative to weight. The coefficient on power windows is negative
in every specification ran, remaining as the only counterintui-
tive result. Finally, the marginal utility of income has the cor-
rect sign and it is statistically different from zero and both qo
and qs lie in the unit interval as required to be consistent with
utility maximization. The estimated coefficients of these
parameters suggest that there is indeed a significant degree of
market segmentation along both origin and size dimensions.
The positive and statistically significant coefficient for the
domestic dummy variable implies an outward shift of the de-
mand curve if a car is Colombian made. The observed home
bias means, given qo less than one, that a car will enjoy certain
degree of protection against foreign competition if it is domes-
tically produced. A likely explanation for this result is related
to the distribution network. The lack of foreign imports in
Colombia during the 1980s implied that when foreign firms en-
tered the market in the 1990s they had to start from scratch.
Not only did they have to set up a distribution network across
the country, they also had to import accessories and spare
parts which made them more expensive and (particularly in
the early nineties) were not as readily available as the Colom-
bian counterparts. A combination of these factors made con-
815
sumers to prefer domestically produced cars, given similar
characteristics.
The results also show stronger preferences for small cars (in
terms of engine displacement) relative to medium and large
cars. This might seem as a rather unexpected result as one
would expect that, everything else constant, consumers would
prefer larger cars. However, large cars (high CC) tend to con-
sume more gasoline and pay higher insurance rates. Since there
is no explicit data on either of these variables, it is likely that
this dummy variable captures such effect thus implying that
consumers will tend to prefer a small rather than a large car.
Table 4 estimates are, therefore, those used to calculate the
consumers’ welfare. Nevertheless, it is well known in the dis-
crete choice literature that the decision of which characteristics
to include is ad hoc. In results not reported, I find that the
model is robust to the choice of characteristics. 30
An alternative model would include brand dummies as in
Nevo (2001). 31 The idea is that some components of the unob-
served characteristics can be captured by these firm fixed
effects. 32 They are expected to capture time invariant character-
istics that vary by car maker. The results are reported in Table 5.
As before, the marginal utility of income has the correct sign
and it is statistically different from zero and both qo and qs lie
in the unit interval. The domestic dummy remains statistically
significant, though the effect is smaller. In a relatively immature
market, with only three traditional domestic firms, consumers
do not differentiate substantively between firms. 33 Thus, firm
fixed effects are capturing effects already captured by the in-
cluded domestic dummy. In terms of engine displacement, med-
ium cars are not statistically preferred to large cars. Foreign
firms entered the markets with a relatively small number of
models, generally allocated with a given car segment. Given that
on average they serve the Colombian market for just 5 years, it
seems reasonable to believe that the firm effects are capturing ef-
fects already captured by the size dummies. Thus, given the spe-
cific structure of the car market in Colombia during the sample
period, the preferred estimates are those reported in Table 4.
(a) Consumers’ welfare and trade liberalization
A natural way to capture the effect of the trade liberalization
process on consumers’ welfare is to compare the post-reform
welfare versus the pre-reform welfare. 34 Taking advantage
of the introduction of new (previously unavailable) foreign
models into the market, it can be argued that the difference
Table 5. Demand estimates (firm fixed effects)
PD GEV estimate (SE)
a 4.854 (2.860)*
qo 0.498 (0.272)*
qs 0.493 (0.213)**
Domestic 0.659 (0.180)***
Small 0.363 (0.142)***
Medium 0.187 (0.121)
Dimension 0.759 (0.641)
HP/W 2.466 (2.592)
AC 0.056 (0.073)
Pwr Windows 0.059 (0.077)*
Constant 19.568 (9.573)***
GMM 41.4
Robust standard errors in parenthesis.
*
Significant at 10% level.
**
Significant at 5% level.
***
Significant at 1% level.
816 WORLD DEVELOPMENT
Table 6. Welfare (1996 dollars)
1986 4,772
1987 4,069
1988 4,512
1989 2,817
1990 2,008
1991 1,746
1992 3,067
1993 7,913
1994 6,841
1995 6,331
1996 7,091
1997 7,551
1998 5,299
1986–91 3,321
1992–98 6,299
1986–98 4,924
Source: Authors calculations.
represents the effects of the trade reforms. Given that prices
fell (Figures 1 and 2) and that the number of models offered
increased (Table 2), theory suggests that consumers’ welfare
should rise after 1992. As discussed in Clerides (2008), the
Ackerberg and Rysman (2005) critic that discrete choice mod-
els tend to overestimate welfare gains from the introduction of
new goods does not apply here because such problem is only
severe in “situations where the new goods are priced outside
the range of previously unobserved prices”. For the most part,
this is not the case here.
The results in Table 6 suggest that, as expected, consumers’
surplus increased after the reforms took place. The average
consumer surplus difference between the post-reform and
pre-reform period was just below three thousand 1996 dollars.
These gains are per purchaser per year. The aggregate implica-
tions are discussed below. Thus, as theory predicts, trade lib-
eralization has a positive effect on consumers’ welfare.
Given the way that the trade liberalization process was
implemented in Colombia the above strategy is valid and
one could argue it is enough to prove the hypothesis. It com-
pares the before and after were the main difference is the exis-
tence of imported cars in the post-reform period. Thus, the
difference in consumers’ surplus is explained by the introduc-
tion of such foreign cars.
But theory suggests that there are two channels through
which trade liberalization can benefit consumers: price reduc-
tions and variety increase. The results reported in Table 6 say
nothing about this, they just quantify the increment in ob-
served consumers’ surplus. Thus, to grasp a complete view
of the effects of the reforms I ask what the consumers’ welfare
would have been in the absence of imported vehicles. In order
to implement this counterfactual scenario all foreign models
are removed from the available choice set, the market shares
of domestic cars alone are re-computed and consumer surplus
is re-estimated.
Given the unavailability of foreign vehicles before the re-
forms, the counterfactual exercise is only relevant from 1992
onward. In such a case, the demand model discussed earlier re-
duces to a one level nested logit where the principle of differ-
entiation is only size. Initially, assuming that prices and
characteristics remain unchanged when the choice set is re-
duced to domestic cars only, Eqn. (5) is calculated.
W Obs ðN Þt1  W Ctfl ðN D Þt1 ; t1 ¼ 92; 93; . . . ; 98 ð5Þ
Obs
where W ðN Þt1 refers to the per purchaser consumer surplus
calculated earlier for N, the entire choice set in period t1.
Table 7. Welfare improvements due to the existence of foreign cars in the
market (Observed Welfare minus Counterfactual Welfare) (1996 US$)
Counterfactual Counterfactual with
with fixed price new equilibrium price
1992 1,153 1,441
1994 2,222 2,765
1996 2,485 2,975
1998 3,082 3,142
1992–98 2,791 2,929
Source: Authors calculations.
W Ctfl ðN D Þt1 is the per purchaser consumer surplus calculated
when only domestic cars are available in the choice set (ND)
and prices remain fixed to actual market prices. Under this
scenario, the first column of Table 7 presents the difference
between the observed consumer welfare and the (new) esti-
mated welfare under the counterfactual assumptions. In the
first year of the reforms, the gains in consumer welfare are
small as few foreign models were available and because
expensive luxurious cars accounted for a large part of the
imported vehicles. The gains per purchaser quickly rose by
1994 when they reached US$2,222. Overall my estimates
suggest that the gains per consumer due to the availability
of imported cars in the Colombian market (increased variety)
were around $2,800. 35
The next step is to relax the assumption that prices of
domestic cars remained unchanged in the absence of imported
vehicles. 36 To do so, I need to re-compute the new equilibrium
price using Eqn. (4) assuming that only domestic cars were
available in the Colombian market. The estimated (average)
increase in the price of domestic vehicles is estimated to be just
below 4%. I recalculate Eqn. (5) where W Ctfl ðN D Þt1 is defined as
before but the expected higher prices due to the (simulated)
lack of foreign completion is now taken into account.
The second column of Table 8 reports welfare gains per pur-
chaser using this new set of prices. As prices are higher, the
estimated consumer’s surplus per purchaser decreases, and,
therefore, the welfare gains of introducing imported vehicles
in the market are slightly greater than those estimated with
fixed price. The average (estimated) increase in consumer wel-
fare per purchaser is $2,929.
When comparing the figure estimated under the fixed price
assumption, one concludes that most of the welfare gains for
consumers came from variety, not from price changes. In fact,
these results suggest that 95.3% of the welfare gains come in
the form of increased variety. This figure is larger than that re-
ported by Fershtman and Gandal (1998) who find that variety
explains 84.6% of consumers’ welfare gains. Contrary to the
Colombian case (where no foreign vehicles were offered prior
to 1992), in Israel, during the Arab Boycott, there were some
American and European imports, plus gradually some Japa-
nese and Korean cars entered the market. Arguably, the thirst
for variety was stronger among Colombian consumers than
among Israeli’s.
Furthermore, note that welfare gains represent around
17% of the average post-reform price of a car. As before,
Fershtman and Gandal (1998) report a lower figure, 9.5%.
The same explanation applies. Gains are relatively more valu-
able for Colombia consumers.
The aggregate figures are also significant. The gains to con-
sumers represent in 1997 (when sales peaked) 0.28% of GDP.
Considering that this represents the gains obtained by just one
sector, the automobile industry, the effect is considerable. This
figure is similar to that found by Clerides (2008) for Cyprus
 CONSUMERS’ WELFARE AND TRADE LIBERALIZATION
were the gains of admitting used cars into the market was cal-
culated to be 0.24% of Cyprus GDP. Fershtman and Gandal
(1998), who focus on the end of the Arab Boycott on Israel
finds, a slightly larger number: 0.30% of Israeli GDP.
7. CONCLUSION
This paper analyzes the effects of the early 1990s trade liber-
alization reforms that were implemented in Colombia. The re-
sults of this natural experiment suggest that the reforms had a
significant impact on the car industry. As tariffs were reduced,
previously unavailable foreign cars were introduced into the
market and car prices dropped. As a consequence, relative
to pre-reform levels, consumers’ welfare increased on average
by almost three thousand dollars per purchaser. Such gains
are, for the most part, explained by an increase in product
variety as opposed to the decline in prices.
Despite the positive effects of the reforms, it is worth noting
that these effects are partial in at least two ways. First, to
NOTES
1. See for instance Krugman (1980) and Melitz (2003) discussion on
consumers’ welfare improvement due to increased variety.
2. Tybout’s review is mostly interested in how trade reforms affect firms’
performance. (Grether, 1996; Haddad, De Melo, & Horton, 1996;
Harrison, 1994; Muendler, 2002; Pavcnik, 2002; Roberts, 1996; Tybout,
1996). He reports mix results, stronger when using plant level data, weaker
when using industry level data.
3. Classic nontrade applications are available in Berry, Levinsohn, and
Pakes (1995), Nevo (2001) and Petrin (2002).
4. Other trade—related uses of these discrete choice models include the
analysis of the effects of Japan’s voluntary imposition of export restraints
to the US Goldberg (1995) finds that the VER were binding in the first
years after they were imposed, while Berry, Levinsohn, and Pakes (1999)
finds the opposite.
5. Random utility in the sense discussed in detail by Train (2003) and
applied by, for instance, Bresnahan, Stern, and Trajtenberg (1997). For
reasons explained in detail later on, this paper does not estimate a random
coefficient model.
6. The working paper version also deals with market performance as
measured byprice—cost margins. At the suggestion of one of the referees I
have narrowed the objective of the paper to one specific effect: gains in
consumers’ welfare.
7. An overview of cross-country regressions can be found in Harrison
(1996), Frankel and Romer, (1999), and Rodrı́guez and Rodrik (2000).
8. See Garay et al., 1998.
9. The program aimed to lower tariffs from an aggregate average level of
around 25% in 1990, to a level of 11% in 1994.
10. Renault owned 60% of the company, Toyota 28% and Mitsui 12%.
817
quantify total domestic welfare on the car industry, this paper
would have to be extended in order to quantify the effects of
the reforms on firms’ profits. No doubt this is an interesting
question and the model derived in this paper would be useful
in such a task. However, fixed cost data, relatively hard to ac-
quire given the historical data used, are necessary to properly
estimate profits. This is an ongoing project to complete the
picture not done in other similar events already described
above.
Second, the paper is focused on one, albeit important, sector
of the economy. A study of the overall impact of the trade re-
forms are out of the scope of this paper. Since the dawn of eco-
nomic theory, it has been clear that international trade has
winners and losers. The findings in this paper show that, given
a durable, relatively expensive good, the increased variety had
a clear impact on consumers’ well being. In this case, it is clear
that no plants were closed and no significant labor realloca-
tions occurred. But nothing can be said in terms of the impact
of the liberalization process on productivity or on the overall
effect on the economy. The latter, remains an open question.
11. An obvious drawback, as pointed out earlier, is that only one
particular market is analyzed. It is common, however, for trade
agreements to give a different treatment to certain sectors, particularly
the auto sector.
12. Goldberg and Verboven (2001) also attempt to estimate their model
using a PD GEV, but they report that this model did not find support in
their data.
13. Although standard, it is worth reviewing the basics because the PD
GEV share function has its own specifics.
14. Train (2003) shows that for q > 1 the model is still consistent with
utility maximizing behavior for some range of the explanatory variables
but not for all values.
15. The market size is assumed to be the number of households that,
given their income, could at least buy the cheapest car each year. This is
approximately 80% of Colombian total households.
16. The model, of course, has certain limitations. As in all other papers
referenced earlier that focus on the auto industry, the new car market is
modeled as if used cars do not matter and if consumers were not forward
looking when buying durable goods. These restrictions are in good part
due to data unavailability of used cars, thus it is not possible to follow
up the stock of such type of vehicles. In the Colombian case, however,
this is probably of less concern than when studying mature markets
because of the relatively small size of the market during the sample
period.
17. Specifically I used the website www.motor.com.co, Internet version
of the specialized Colombian auto magazine Motor. Earlier years required
the printed version.
18. Though sales information for both SUV’s and pickups was available,
unfortunately characteristics data was not.
818 WORLD DEVELOPMENT
19. Tariffs data are provided by the National Planning Department and
the value added tax by the Ministry of Finance. The real exchange index
was constructed on a per country of origin basis (CKD, when the car is
domestic) using each country’s CPI and the nominal exchange rate. This
strategy guarantees that all three variables vary within and across years.
20. A detailed explanation on the behavior of the number of models
offered is out of the scope of this paper. I should emphasize that my
objective is to study the effects of such increase in variety on consumers’
welfare, not on explicitly explaining the changes in such variety. However,
both referees did note that the post reform slight increase in the number of
models offered by Domestic firms is a characteristic worth pointing out. A
referee suggested that this could be related to a productivity increment as
discussed by Eckel and Neary (2010). However, these authors also predict
a reduction in product variety. And although such reduction is observed in
1993, the trend seems relatively stable afterward. A complementary
argument is the one suggested by Bernard et al. (2011) and discussed in the
text.
21. The average US price is from the US Department of Commerce,
Bureau of Economic Analysis, National Income and Product Accounts.
22. Prices for US cars are not adjusted for quality due to the lack of US
detailed information.
23. I thank a referee for suggesting this exercise.
24. It is insufficient because there is no production or assembly cost data
for imported vehicles.
25. I exploit the fact that the CKD is the 70% of a cost of a domestically
assembled car. Thus origin of the CKD determines the origin of the
domestically assembled car.
26. This is particularly true in the Colombian case because both domestic
firms and importers are very small players relative to the world auto
industry. As a consequence, they have no power to influence over the
design of cars and their corresponding characteristics.
27. Used for instance in Hausman, Leonard, and Zona (1994) and Nevo
(2001).
28. Although market is defined in this paper as year (Eqn. (1)), in this
particular context I refer to other countries as other “markets”.
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29. In most cases, the sample period does not even match with that in my
paper.
30. The results are reported in the working version of the paper. Two
robustness tests were performed. First, given its nonsignificance, the air
conditioning dummy was dropped from the main specification. Second,
dimension is excluded because one might be concerned that both size
(measured as engine displacement) and dimension (measured as length
times width) are included. In both cases, the results from the preferred
specification are valid as the estimated coefficients do not change
significantly.
31. Unlike in my case, Nevo (2001) has to deal with the fact that
observed characteristics vary very little across markets.
32. At the suggestion of a referee a specification using model fixed effects
was ran but it was not supported by the data, that is no convergence was
achieved.
33. For instance, for the US, Train and Winston (2007) find that
consumers care more about the characteristics of the cars than on brand
loyalty.
34. Consumer surplus is estimated following the principles described in
Trajtenberg (1989).
35. To avoid confusion recall that earlier I found the increase in
consumer welfare to be $2,978 per purchaser, when comparing the pre and
post reform period. The $2,791 figure should be taken as the increase in
consumers’ welfare due to a variety increase (from foreign vehicles) in the
Colombia market.
36. I will however keep the assumption that characteristics of domestic
cars are the same independent of the availability of foreign cars. Given the
trend of characteristics observed in Table 1, it seems a plausible
assumption.
37. Specifically G(.) has to be nonnegative, homogenous of degree r,
(where r P 0), lim. G(.) ! 1 as eVj ! 1, for j = 0. . .J, and mixed
partials of G(.) must alternate in sign with first partial nonnegative.
38. Particularly when dealing with models where nonlinearities arise.
39. The J products plus a normalized outside good.
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APPENDIX 1
Suppose that consumer i will buy car j if he/she reports a
higher utility, that is:
819
U ðxjt ; njt ; pjt ; eijt ; hÞ P U ðxrt ; nrt ; prt ; eirt ; hÞ; for r ¼ 1 . . . J
The model must take into account the possibility that consum-
ers may not want to buy a new car. Ignoring this possibility
would imply that an even change in the price of all cars will
have no effect over demand and so, the substitution patterns
would be biased. Let Ajt be the set of values for e such that
the consumer decides to buy good j.
Ajt ¼ fe : U ðxjt ; njt ; pjt ; eit ; hÞ P U ðxrt ; nrt ; prt ; eit ; hÞ;
for r ¼ 0; 1; . . . J g
Assuming ties occur with zero probability, and given P0(e), the
density of e in the population, the market share of the jth good
as a function of the J + 1 goods competing in the market is:
Z
sjt ðx:t ; p:t ; n:t ; hÞ ¼ P o ðeÞ ðA:1Þ
e2Ajt
where xt = (x1t,. . .,xJt). Similarly for p and n. Dropping the t
subscript, and defining M to be the size of the market, the J-
vector of demands is Msj(p,x,n;h).
The integral in Eqn. (A.1) can be computed either analyti-
cally or numerically depending on the distribution assumption
made for eij. If eij is assumed to be independently and identi-
cally distributed across choices, if it is believed multivariate ex-
treme value and if no additional heterogeneity (beyond the eij
term) is assumed, then the integral can be solved analytically.
Specifically, letting Vij = aln(yi  pj) + dj and making use of
McFadden (1978) the share function can be derived. That pa-
per shows that if F(eio,. . .,eiJ) denotes the J + 1 dimensional
CDF of e, and G(y0,. . .,yJ) is a nonnegative, homogeneous
of degree one function satisfying certain restrictions, 37 then
F ðeio ; . . . ; eiJ Þ ¼ expðGðeeio ; . . . ; eeiJ ÞÞ is the multivariate ex-
treme value distribution, and
eV ij Gj ðeV io ; . . . ; eV iJ Þ
S ij ¼
GðeV io ; . . . ; eV iJ Þ
is the market share equation of product j, where Gj is the par-
tial derivative of G with respect to eVij
APPENDIX 2
Under a pure Bertrand-Nash equilibrium, the resulting
prices must satisfy the following first order condition,
X @sr ðpÞ
sj ðpÞ þ ðpr  mcr Þ ¼0
r2J
@pj
f
where dsr(p)/dpj comes from the demand model.
The markups can be solved by defining a J  J matrix X
whose (j,r) elements are given by:
( @s
 @pr ; if r and j are produced by the same firm;
X¼ j
0; otherwise
In vector notation the above first order conditions become
sðpÞ  Xðp  mcÞ ¼ 0
Noting that s(.), p and mc are J  1 vectors, the markup can
be estimated by solving for p  mc
ðp  mcÞ ¼ X1 sðpÞ
820 WORLD DEVELOPMENT
APPENDIX 3
A straightforward strategy to estimate the model is to
choose parameters that minimize the distance between the pre-
dicted and the observed market shares:
Min ksðx:; p:; n; hÞ  S k ðA:2Þ
h fine the following generalized method of moment estimator
where s(.) are the predicted market shares and S the observed
market shares. However, the expected correlation between
prices and the unobserved characteristics as well as other com-
putational issues led Berry (1994) to develop a technique that
deals with these complications. 38
Berry (1994) defines n as a structural error term, rather than
as the difference between the observed and predicted market
shares as is done in Eqn. (A.3). As shown in Eqn. (1), the mean
utility dj(.), is linear in nj. Consequently, given the predicted
and observed market shares solve for d the following system
of J + 1 equations: 39
sðd; hÞ ¼ S: ðA:3Þ
Eqn. (A.3) cannot be solved analytically due to the presence of
three nonlinear parameters, a, qo, and qs. Therefore, using a
nonlinear numerical procedure d is derived as a function of
the observed market share and the nonlinear parameters.
Define Z = [z1,. . .,zM] to be a set of instruments such that
E½Z m  xðh Þ ¼ 0; m ¼ 1 . . . M; ðA:4Þ
where x, a function of the true parameters h*, is an error term
defined as,
x ¼ dð:Þ  X b  n
The moment condition given in Eqn. (A.4) can be used to de-
(GMM):
0
min L ¼ xðhÞ ZA1 Z 0 xðhÞ ðA:5Þ
a;b;q
where A is a consistent estimate of E[Z0 xx0 Z].
As is, the GMM estimator involves a potentially large set of
parameters to estimate. However, noting that the b parameters
enter linearly, the minimization in (A.5) can be performed only
with respect to the nonlinear parameters a and the q’s. The b’s
are estimated as follows:
b ¼ ðX 0 ZA1 Z 0 X Þ1 X 0 ZA1 Z 0 dðs; a; qÞ; ðA:6Þ
This expression is then plugged into the objective function
(A.5).
A higher unobserved product quality, n should lead firms to
set higher prices. Additionally, due to the firms’ first order
conditions, n will also be correlated with the prices and the
market shares of the other products.