Working Paper: CEPR ID: DP1326
Authors: Antonio Cabrales; Massimo Motta
Abstract: We analyse the effects of trade liberalization on firms' decisions and profits, and on consumers' welfare, in a product differentiation model with countries of different size. Firms decide product specifications at the beginning of the game, in which autarky is followed by trade liberalization (whose date is anticipated). Despite the heterogeneity, the highest level of welfare is attained for both countries when trade opens immediately. The impact on firms' profits can differ, however. Small country's firms benefit from larger market size but are disadvantaged when the scale of the home market affects the product choice decision. The opposite is true for the firm located in the large country.
Keywords: trade liberalization; product differentiation; international trade; country size
JEL Codes: F12; F15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| timing of trade liberalization (F13) | firms' investment decisions in product quality (L15) |
| firms' investment decisions in product quality (L15) | profitability (L21) |
| timing of trade liberalization (F13) | profitability (L21) |
| delay in trade liberalization (F13) | firms' ability to invest in higher quality products (L15) |
| delay in trade liberalization (F13) | competitiveness of small country firms (F23) |
| speed of trade liberalization (F13) | firms' competitiveness (F23) |
| immediate trade liberalization (F13) | welfare for both countries (I39) |
| relative size of firms (L25) | benefits from trade (F10) |
| market size (L25) | investment in product quality (L15) |