Allocative Efficiency, Mark-Ups, and the Welfare Gains from Trade

Abstract

This paper develops an index of allocative efficiency that depends upon the distribution of mark-ups across goods. It determines how changes in trade frictions affect allocative efficiency in an oligopoly model of international trade, decomposing the effect into the cost-change channel and the price-change channel. Formulas are derived shedding light on the signs and magnitudes of the two channels. In symmetric country models, trade tends to increase allocative efficiency through the cost-change channel, yielding a welfare benefit beyond productive efficiency gains. In contrast, the price-change channel has ambiguous effects on allocative efficiency.