International commodity trade, transport costs, and product differentiation

Transport costs and product quality have received increased attention in the international trade literature. Product quality is a particularly important factor in international trade of high-valued commodities. We observe that significant transport costs for a relatively high quality product represent a natural trade barrier. In this case, transport costs may introduce product differentiation, protecting home-country production of the higher quality product and constraining the foreign exporter to shipping a lower quality substitute. With differential transport costs between a higher and a lower quality product, firms in both countries may gain by implicitly coordinating in an increasingly segmented market and choosing a high-price strategy for both products. Home-country producers clearly gain. Through product differentiation in an oligopolistic market, the foreign producers may also gain when the home producers exploit the transport cost advantage. The international orange juice market, with significant trade volumes in both lower quality frozen-concentrated juice and higher quality not-from-concentrate juice, provides compelling evidence supporting this model.