In international trade class, we assume homothetic preferences for every country, and each country has an endowment. Why do we assume homothetic preferences? Is this because we see (from data) that relative price changes are what drive trade patterns, and not income, or are there other reasons?
(This is half of a post that I split into two separate questions.)
There is some evidence for homothetic preference amongst large number of countries, although there are for sure bound to be cases that violate this assumption.
For example, Choi & Krishna (2004), show indirect empirical evidence for this. As the authors report (my comments in [])
The restrictions [including homothetic preferences] implied by the theory for overall (i.e., bidirectional) bilateral trade flows are satisfied for the vast majority of country pairs in our sample. Having said this, we must note that in many cases, the theory is only “just” satisfied. Nevertheless, this finding stands in strong contrast with many previous tests of the theory that were conducted under the restrictive assumptions of identical factor prices and identical homothetic preferences
The authors do this by seeing if the estimations from unrestricted models are in line with what the models with the restrictions would predict. Since they dont find much significant differences it stands to reason that this implies the restrictions are valid.
