Trade Theory with Behavioral Agents

I develop a theoretical framework to study gains from trade and optimal tariffs in the presence of behavioral biases. I introduce a sufficient statistic, called “behavioral wedge,†that generalizes the model to capture various types of behavioral biases, including utility misperceptions and inattention. First, I explore how behavioral biases influence gains from trade, demonstrating potential welfare losses from trade for behavioral agents. Second, I characterize optimal tariffs and behavioral nudges in the presence of behavioral biases. I show that small open economies can leverage trade policy to mitigate the welfare losses from behavioral biases, whereas larger economies might use nudges to manipulate the world’s terms of trade. Finally, I discuss the role of behavioral biases in shaping public support for the 2018 China–United States trade war and Brexit.