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Welfare Effects of Trade Liberalization with Intra-industry Reallocations: The Importance of Preferences and Market Failures

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  • Allan Sørensen

    () (School of Economics and Management, Aarhus University, Denmark)

Abstract

This paper shows that the novel gains from trade liberalization driven by intra-industry reallocations (Melitz (2003)) are not robust to changes in the preference structure. In the Melitz (2003) setting the unambigousness of the welfare effect depends crucially on the assumption of traditional CES pref- erences, which ensures equivalence of the market equilibrium and the social planner solution. For other preferences this equivalence is broken and trade liberalization may reduce welfare by magnifying market failures. An exact condition for trade liberalization to reduce overall welfare is derived under the assumptions of generalized CES preferences and a specific distribution (Pareto) of firm heterogeneity.

Suggested Citation

  • Allan Sørensen, 2010. "Welfare Effects of Trade Liberalization with Intra-industry Reallocations: The Importance of Preferences and Market Failures," Economics Working Papers 2010-02, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:aarhec:2010-02
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    File URL: ftp://ftp.econ.au.dk/afn/wp/10/wp10_02.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Heterogenous firms; monopolistic competition; trade liberalization; welfare;

    JEL classification:

    • D6 - Microeconomics - - Welfare Economics
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F15 - International Economics - - Trade - - - Economic Integration

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