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Trade Liberalization and Welfare Inequality: a Demand-Based Approach

  • Tarasov, Alexander

There is strong evidence that different income groups consume different bundles of goods. This evidence suggests that trade liberalization can affect welfare inequality within a country via changes in the relative prices of goods consumed by different income groups (the price effect). In this paper, I develop a framework that enables us to explore the role of the price effect in determining welfare inequality. There are two core elements in the model. First, I assume that heterogenous in income consumers share identical but nonhomothetic preferences. Secondly, I consider a monopolistic competition environment that leads to variable markups affected by trade and trade costs. I find that trade liberalization does affect the prices of different goods differently and, as a result, can benefit some income classes more than others. In particular, I show that the relative welfare of the rich with respect to that of the poor has a hump shape as a function of trade costs.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20199.

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Date of creation: Jan 2008
Date of revision: Jan 2010
Handle: RePEc:pra:mprapa:20199
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  1. Pinelopi Koujianou Goldberg & Nina Pavcnik, 2007. "Distributional Effects of Globalization in Developing Countries," Journal of Economic Literature, American Economic Association, vol. 45(1), pages 39-82, March.
  2. Flam, Harry & Helpman, Elhanan, 1987. "Vertical Product Differentiation and North-South Trade," American Economic Review, American Economic Association, vol. 77(5), pages 810-22, December.
  3. Markusen, James R, 1986. "Explaining the Volume of Trade: An Eclectic Approach," American Economic Review, American Economic Association, vol. 76(5), pages 1002-11, December.
  4. Stibora, Joachim & de Vaal, Albert, 2007. "Trade policy in a Ricardian model with a continuum of goods under nonhomothetic preferences," Journal of Development Economics, Elsevier, vol. 84(1), pages 350-377, September.
  5. Kiminori Matsuyama, 1999. "A Ricardian Model with a Continuum of Goods under Non-homothetic Preferences: Demand Complementarities, Income Distribution, and North-South Trade," Discussion Papers 1241, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Marc J. Melitz & Gianmarco I.P. Ottaviano, 2005. "Market Size, Trade, and Productivity," Development Working Papers 201, Centro Studi Luca d\'Agliano, University of Milano.
  7. Pablo D. Fajgelbaum & Gene M. Grossman & Elhanan Helpman, 2009. "Income Distribution, Product Quality, and International Trade," NBER Working Papers 15329, National Bureau of Economic Research, Inc.
  8. Devashish Mitra & Vitor Trindade, 2005. "Inequality and trade," Canadian Journal of Economics, Canadian Economics Association, vol. 38(4), pages 1253-1271, November.
  9. Tarasov, Alexander, 2009. "Income distribution, market structure, and individual welfare," Munich Reprints in Economics 19578, University of Munich, Department of Economics.
  10. Kevin M. Murphy & Andrei Shleifer & Robert Vishny, 1988. "Income Distribution, Market Size, and Industrialization," NBER Working Papers 2709, National Bureau of Economic Research, Inc.
  11. Stokey, Nancy L, 1991. "The Volume and Composition of Trade between Rich and Poor Countries," Review of Economic Studies, Wiley Blackwell, vol. 58(1), pages 63-80, January.
  12. P Ramezzana, 2000. "Per Capita Income Demand for Variety, and International Trade: Linder Reconsidered," CEP Discussion Papers dp0460, Centre for Economic Performance, LSE.
  13. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
  14. Jonathan Eaton & Samuel Kortum, 2002. "Technology, Geography, and Trade," Econometrica, Econometric Society, vol. 70(5), pages 1741-1779, September.
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