𝑌 ∗ 𝑒 𝑃∗ 𝑒

𝑋𝑖𝑑 = 𝑓 ( , ) (3.9)
𝑃𝑖 𝑃𝑖

Where Y*e/Pi is the level of real income in ROW and P*e/Pi is relative prices.

3.1.2 Export Demand Model

In deriving a tractable model of aggregate export demand the most important

considerations (assumptions) made by Senhadji and Montenegro (1998) were: time

series properties, a model which data requirements do not exceed data availability,

and a model that makes no difference between producer goods and consumer goods

(“no production sector”). These strong assumptions are in line with the

methodological design of the present work as it is very common in developing and

emerging countries that disaggregated data are nonexistent or difficult to obtain.

Furthermore, Senhadji and Montengro (1998) assumed a two country world where the

home country is defined as the exporter and ROW as the importer. Therefore home

export demand (xt) is equal to ROW import demand (It*).2 Import decisions in ROW

are taken by an “infinitely-lived representative agent” who maximizes utility by

allocating consumption between domestic (dt*) and imported goods (It*):

max E0 ∑(1 + 𝛿)−1 𝑢(𝑑𝑡∗ , 𝐼𝑡∗ ) (3.10)

{𝑑𝑡∗ ,𝐼𝑡∗ }𝑡=0
𝑡=0

Subject to:
∗
𝑏𝑡+1 = (1 + 𝑟)𝑏𝑡∗ + (𝑒𝑡∗ − 𝑑𝑡∗ ) − 𝑝𝑡 𝐼𝑡∗ (3.11)

𝑒𝑡∗ = (1 − 𝜌)𝑒̅∗ + 𝜌𝑒𝑡−1

∗
+ 𝜀𝑡∗ (3.12)
∗
𝑏𝑇+1
lim (3.13)
𝑇→∞ ∏𝑇
𝑡=0(1 + 𝑟)
−1

2
xt and It* are the same as Xdi and Idi, respectively, in the imperfect substitutes model.

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