Trade Policies, Firm Heterogeneity, and Variable Markups

We study unilateral trade liberalization in the model with variable markups. First, we show that the effect of falling per unit trade costs depends on the use of the outside good assumption: in its presence trade liberalization reduces welfare at home, and raises it otherwise. Second, we derive the optimal values of import tariffs for the large and small economies and show that in both cases protection is a desirable policy. Finally, we demonstrate that compared to the models with constant markups, variable markups in our setting result in negative pro-competitive effects, reducing gains from trade.