DP9826 Welfare and Trade Without Pareto

Author(s): Keith Head, Thierry Mayer, Mathias Thoenig
Publication Date: February 2014
Keyword(s): Pareto, trade, welfare
JEL(s): F1
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9826

Quantifications of gains from trade in heterogeneous firm models assume that productivity is Pareto distributed. Replacing this assumption with log-normal heterogeneity retains some useful Pareto features, while providing a substantially better fit to sales distributions?especially in the left tail. The cost of log-normal is that gains from trade depend on the method of calibrating the fixed cost and productivity distribution parameters. When set to match the size distribution of firm sales in a given market, the log-normal assumption delivers gains from trade in a symmetric two country model that can be twice as large as under the Pareto assumption.