TY  - JOUR
AU  - Demidova,Svetlana
AU  - Rodríguez-Clare,Andrés
TI  - Trade Policy under Firm-Level Heterogeneity in a Small Economy
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13688
PY  - 2007
Y2  - December 2007
UR  - http://www.nber.org/papers/w13688
L1  - http://www.nber.org/papers/w13688.pdf
N1  - Author contact info:
Svetlana Demidova
Department of Economics
McMaster University
Canada
E-Mail: demidov@mcmaster.ca

Andres Rodriguez-Clare
University of California at Berkeley
Department of Economics
Berkeley, CA 94720-3880
E-Mail: andres1000@gmail.com
AB  - 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.
ER  -