Modeling Marketing Services and Assessing Their Welfare Impacts in a General Equilibrium Framework

Since nearly every good purchased by consumers must pass through the distribution (or marketing) sector, it plays an important role in any modern economy, exerting a strong influence on prices and overall welfare. Most Applied General Equilibrium (AGE) models, however, do not explicitly account for marketing. These models assume that consumers pay producer prices (corrected for taxes and subsidies) and that all distribution services can be lumped into a single sector. In reality, consumer prices are substantially higher than producer prices, and the gap between the two depends on the good being purchased and on the purchaser. Accounting for these facts requires explicit modeling of marketing. Failure to do so within an AGE model may lead to misleading results and will prevent one from analyzing the welfare effects of changes within this crucial sector. In this paper, we explicitly model marketing within an AGE framework. For the first time, to our knowledge, we compare two alternative approaches to such modeling with each other and with the standard approach of not modeling marketing. We do so by running trade opening simulations using each approach. We find that modeling marketing may have a large influence on trade simulations in some cases, while, in other cases, it probably does not. We also exploit our modeling to explore the possible welfare effects of increased efficiency in marketing. We find large potential gains. For the EU and the US, a mere 3% reduction in final goods marketing margins would create the same benefits for these regions as worldwide free trade. For Japan, it would only take a 10% reduction in its high margins. Thus, modest improvements in marketing efficiency may be more beneficial than any possible trade agreement. We also find that reducing margins has a smaller affect on production than does trade opening, so that streamlining distribution may be politically more feasible than trade opening.