GEP Research Paper 98/02

The Economics of Trade in Variety

Zhihao Yu

Abstract

This paper develops a two-country general equilibrium model to examine the costs and benefits of trade in differentiated products. It focuses on how the relative ability in exporting variety determines the welfare of each country. While the analysis suggests a new rationale for export-promotion, it also shows the possibility of overprovision of export variety. It is shown that the variety of consumption goods for a country could be less in free trade than in autarky and, more surprisingly, free trade is not necessarily superior to autarky. Even when trade increases the variety of consumption goods for both countries, the equilibrium of economic integration could be welfare reducing as long as trade cost is positive.

Issued in December 1998.

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