Trade, Competition, and Efficiency
CIRPEE Working Paper No. 09-40
23 Pages Posted: 22 Sep 2009
Date Written: September 22, 2009
We present a general equilibrium model of monopolistic competition featuring pro-competitive effects and a competitive limit, and investigate the impact of trade on welfare and efficiency. Contrary to the constant elasticity case, in which all gains from trade are due to product diversity, our model allows for a welfare decomposition between gains from product diversity and gains from pro-competition effects. We then show that the market outcome is not efficient because too many firms operate at an inefficiently small scale by charging prices above marginal costs. Using pro-competitive effects and the competitive limit, we finally illustrate that trade raises efficiency by narrowing the gap between the equilibrium utility and the optimal utility.
Keywords: Pro-competitive effects, competitive limit, excess entry, trade and efficiency, monopolistic competition
JEL Classification: D43, D51, F12
Suggested Citation: Suggested Citation