Corporate Taxation and Multinational Activity

same way with the homogeneous good Z .

3.1 Households

Preferences are assumed to be a Cobb-Douglas nest of the homogeneous Z-
good and the differentiated X -good. The price of Z serves as the num´eraire. Ui
describes the utility function of a representative household in country i, where
μ denotes the fixed expenditure share for differentiated products and σ > 1 is
the elasticity of substitution between differentiated product varieties:

Transportation of the differentiated X -good across the border is subject to
iceberg transport costs (τ) for the shipment of each unit. Z-goods, in contrast,
are costlessly tradeable.

For each firm type and location, the utility maximization of consumers yields
demand for a single variety of manufactures

Xji  =  Ppki} ^σpσ^- 1 μE  ∀  i ∈{ 1, 2} ∧  ∀  k ∈{n,h}

Xkii  =  (j´ ^-σ Pi^σ-1 μEi  ∀  i = j ∈{ 1, 2}  ∧  ∀  k ∈{h,v}

Xj  =  (PVji}^-σ pσ^- 1 μEi  ∀  i = j ∈{ 1, 2}

Xnji  =  (Pnji)' Pk^- 1 μEi  ∀  i = j ∈{ 1, 2}∙                        (2)

Ei represents the total expenditures of consumers in country i. The price index
Pi of differentiated goods consumed in country i can be written as

ni (Pki) 1^-σ + nj (Pnji¢ 1 -^σ + hi (Pki´ 1 -^σ

1

(j ∖ 1 —σ                i _zτ.              s^izτ 1—

Pai)     + vi (Pvji ¢     + ^vj (P^υvii ¢

Expenditures for X and Z are allocated as follows:

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