How Preferences Shape the Welfare and Employment Effects of Trade

Hartmut Egger () and Simone Habermeyer

No 188, Working Papers from Bavarian Graduate Program in Economics (BGPE)

Abstract: We set up a trade model with two countries, two sectors, and one production factor, which features a home-market effect due to the existence of trade costs. We consider search frictions and firm-level wage bargaining in the sector producing differentiated goods and a perfectly competitive labor market in the sector producing a homogeneous good. Consumers have price-independent generalized-linear preferences over the two types of goods, covering homothetic and quasilinear preferences as two limiting cases. We show that trade between two countries that differ in their population size leads to an expansion of the differentiated goods sector and a contraction of the homogeneous good sector in the larger economy. This induces the larger country to net-export differentiated goods at the cost of a higher economy-wide rate of unemployment in the open economy (with the effects reversed for the smaller country). The welfare effects of trade depend on the preference structure. Looking at the two limiting cases, we show that the larger country is likely to bene?t from trade if preferences are homothetic,whereas losses from trade are possible if preferences are quasilinear. The opposite is true in the smaller country. This reveals an important role of preferences for the welfare effects of trade in the presence of labor market imperfection, a result we further elaborate on in two extensions, in which we consider more general preferences and differences of countries in their per-capita income levels.

Keywords: Preferences; Search frictions; Wage bargaining; Trade structure; Welfare and employment effects (search for similar items in EconPapers)
JEL-codes: D11 F12 F15 F16 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2020-02
New Economics Papers: this item is included in nep-int
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https://bgpe.cms.rrze.uni-erlangen.de/files/2023/0 ... Effects-of-Trade.pdf First version, 2020 (application/pdf)

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