Department of Economics and Business Economics

Welfare Effects of Trade Liberalization with Intra-industry Reallocations: The Importance of Preferences and Market Failures

Research output: Working paperResearch


  • Wp10 02

    Final published version, 282 KB, PDF document

  • School of Economics and Management
This paper shows that the novel gains from trade liberalization driven by
intra-industry reallocations (Melitz (2003)) are not robust to changes in the
preference structure. In the Melitz (2003) setting the unambigousness of the
welfare effect depends crucially on the assumption of traditional CES pref-
erences, which ensures equivalence of the market equilibrium and the social
planner solution. For other preferences this equivalence is broken and trade
liberalization may reduce welfare by magnifying market failures. An exact
condition for trade liberalization to reduce overall welfare is derived under
the assumptions of generalized CES preferences and a specific distribution
(Pareto) of firm heterogeneity.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages24
Publication statusPublished - 2010

    Research areas

  • Heterogenous firms, monopolistic competition, trade liberalization, welfare

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