How Preferences Shape the Welfare and Employment Effects of Trade

Titelangaben

Egger, Hartmut ; Habermeyer, Simone:
How Preferences Shape the Welfare and Employment Effects of Trade.
Bavarian Graduate Program in Economics (BGPE)
Nürnberg , 2020 . - (BGPE Discussion Paper ; 188 )

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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 benefit 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.