DP9839 | Together at Last: Trade Costs, Demand Structure, and Welfare

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We show that relaxing the assumption of CES preferences in monopolistic competition has surprising implications when trade is restricted. Integrated and segmented markets behave very differently, the latter typically implying a form of reciprocal dumping. Globalization and lower trade costs have very different effects: the former reduces spending on all existing varieties, the latter switches spending from home to imported varieties; in the plausible case where demands are less convex than CES, globalization raises firm output whereas lower trade costs reduce it. Finally, calibrating gains from trade is harder. Many more parameters need to be calibrated than in the CES case, while import demand elasticities are likely to overestimate the true elasticities, and so underestimate the gains from trade.