Trade Policy under Firm-Level Heterogeneity in a Small Economy

Svetlana Demidova and Andres Rodriguez-Clare

No 13688, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper we explore the effect of trade policy on productivity and welfare in the now standard model of firm-level heterogeneity and product differentiation with monopolistic competition. To obtain sharp results, we restrict attention to an economy that takes as given the price of imports and the demand schedules for its exports (a "small economy"). We first establish that welfare can be decomposed into four terms: productivity, terms of trade, variety and curvature, where the latter is a term that captures heterogeneity across varieties. We then show how a consumption subsidy, an export tax, or an import tariff allow our small economy to deal with two distortions that we identify and thereby reach its first best allocation. We also show that an export subsidy generates an increase in productivity, but given the negative joint effect on the other three terms (terms of trade, variety and curvature), welfare falls. In contrast, an import tariff improves welfare in spite of the fact that productivity falls.

JEL-codes: F1 F12 F13 (search for similar items in EconPapers)
Date: 2007-12
New Economics Papers: this item is included in nep-int
Note: ITI
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Citations: View citations in EconPapers (8)

Published as Demidova, Svetlana & Rodríguez-Clare, Andrés, 2009. "Trade policy under firm-level heterogeneity in a small economy," Journal of International Economics, Elsevier, vol. 78(1), pages 100-112, June.

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Journal Article: Trade policy under firm-level heterogeneity in a small economy (2009)
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