Abstract

How do information frictions affect international prices and trade? In a standard, two-country Armingtonmodel of trade, information frictions impede the coordination of exporting behavior across countries. Because the terms of trade depend on relative exports, less coordination leads to more volatile terms of trade. Volatility in the terms of trade has the potential to reduce the level of trade by making trade more risky, but it also has the potential to increase the level of trade by increasing the expected terms of trade. We derive general conditions on preferences as to which of these forces—the increase in risk or increase in return—dominate. With CES preferences, as long as goods are not too substitutable, information frictions impede trade. With empirically plausible elasticities of substitution, information frictions facilitate trade.