The Gains from Trade with Monopolistic Competition: Specification, Estimation, and Mis-Specification

52 Pages Posted: 15 Sep 2002 Last revised: 28 Oct 2010

See all articles by Huiwen Lai

Huiwen Lai

SAS Institute Inc.

Daniel Trefler

University of Toronto - Rotman School of Management; National Bureau of Economic Research (NBER)

Date Written: September 2002

Abstract

The difficulty of incorporating general equilibrium price effects into econometric estimating equations has deterred most researchers from econometrically estimating the welfare gains from trade liberalization. Using a paired-down CES monopolistic competition example, we show that this difficulty has been greatly exaggerated. Along the way, we estimate indeed precisely estimate large welfare gains from trade liberalization as measured by compensating variation. Unlike calibration methods, econometric methods allow researchers to isolate the violence done by the model to the data. We find that the CES monopolistic competition model horribly mis-specifies behavioural price elasticities and general equilibrium price feedbacks. The model as conceived is therefore of limited value for analysing the effects of trade liberalization. We report a number of specification issues that should point the way to better theoretical modeling.

Suggested Citation

Lai, Huiwen and Trefler, Daniel, The Gains from Trade with Monopolistic Competition: Specification, Estimation, and Mis-Specification (September 2002). NBER Working Paper No. w9169. Available at SSRN: https://ssrn.com/abstract=330308

Huiwen Lai

SAS Institute Inc. ( email )

100 SAS Campus Drive
Cary, NC 27513-2414
United States

Daniel Trefler (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-4190 (Phone)
416-978-6713 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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