Optimal Trade Policy with Monopolistic Competition and Heterogeneous Firms

33 Pages Posted: 23 Jan 2015

See all articles by Jan I. Haaland

Jan I. Haaland

Norwegian School of Economics (NHH) - Department of Economics; Centre for Economic Policy Research (CEPR)

Anthony J. Venables

University of Oxford; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 12, 2014

Abstract

This paper derives optimal trade and domestic taxes for a small open economy containing a monopolistically competitive (MC) sector in which firms may have heterogeneous productivity levels. Analysis encompasses cases in which the domestic MC sector is able to expand or contract flexibly, or is constrained to be of fixed size. In the former case domestic protection can bring gains by increasing the number of product varieties on offer; these gains (and the corresponding rates of domestic subsidy or of import tariffs) are reduced by heterogeneity of foreign exporters some of whom may withdraw from the market. In the latter case gains from protection arise from terms-of-trade effects; since various margins of substitution are switched off, only the relative values of domestic taxes, import tariffs and export taxes matter. In general, policies work through both a terms-oftrade and a variety effect, and the paper shows how the relative importance of each depends on the structure of the economy.

Keywords: Trade policy, monopolistic competition, heterogeneous firms, terms of trade, variety

JEL Classification: F12, F13

Suggested Citation

Haaland, Jan I. and Venables, Anthony J., Optimal Trade Policy with Monopolistic Competition and Heterogeneous Firms (November 12, 2014). NHH Dept. of Economics Discussion Paper No. 33/2014. Available at SSRN: https://ssrn.com/abstract=2553821 or http://dx.doi.org/10.2139/ssrn.2553821

Jan I. Haaland (Contact Author)

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
Bergen, N-5045
Norway
+4755959255 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Anthony J. Venables

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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