DP10255 New trade models, elusive welfare gains

Author(s): Kristian Behrens, Yoshitsugu Kanemoto, Yasusada Murata
Publication Date: November 2014
Keyword(s): cardinalization, new trade models, product diversity, subutility function, welfare gains from trade
JEL(s): F11, F12
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10255

We generalize the formulae for welfare changes by Arkolakis, Costinot, and Rodríguez-Clare (2012) and Melitz and Redding (2014a) to allow for various cardinalizations of the subutility functions for varieties. Despite the same macro restrictions and the same equilibrium allocations, our new formula coincides with the original ones if and only if the number of varieties is invariant to foreign shocks. When product diversity responds to foreign shocks, different cardinalizations generate different welfare changes, thus revealing a fundamental difficulty in quantifying welfare gains implied by new trade models.