DP9839 Together at Last: Trade Costs, Demand Structure, and Welfare

Author(s): Monika Mrázová, J Peter Neary
Publication Date: February 2014
Keyword(s): Additively Separable Preferences, CES Preferences, Iceberg Trade Costs, Quantifying Gains from Trade, Super- and Subconcavity of Utility, Super- and Subconvexity of Demand
JEL(s): F12, F15, F17
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9839

We show that relaxing the assumption of CES preferences in monopolistic competition has surprising implications when trade is restricted. Integrated and segmented markets behave very differently, the latter typically implying a form of reciprocal dumping. Globalization and lower trade costs have very different effects: the former reduces spending on all existing varieties, the latter switches spending from home to imported varieties; in the plausible case where demands are less convex than CES, globalization raises firm output whereas lower trade costs reduce it. Finally, calibrating gains from trade is harder. Many more parameters need to be calibrated than in the CES case, while import demand elasticities are likely to overestimate the true elasticities, and so underestimate the gains from trade.