Working Paper: CEPR ID: DP18089
Authors: Peter Egger; Ruobing Huang
Abstract: The inefficiency of the market under monopolistic competition and heterogeneous firms in closed economies is well established. However, insights regarding asymmetric countries which are open to trade are less developed. This paper offers a systematic analysis of this question using general demand structures and productivity distributions. First, we derive sufficient conditions that constrain the space of exogenous parameters, ensuring the existence and uniqueness of general equilibrium. Next, we demonstrate that distortions from a global social planner’s perspective in open economies can be described as shift effects on production schedules, resulting from differences in the fundamentals of asymmetric countries, and rotation effects on production schedules, determined by the demand structure. We apply these insights to quantify the distortions in terms of cutoffs, quantities, and welfare for China and the Rest of the World. Our results indicate that both economies have weak selections, with relatively more overproducing firms selling to China and more underproducing firms selling abroad. Additionally, we find that in some cases, China attains higher welfare levels under the market than the global social optimum
Keywords: misallocation; heterogeneous firms; trade
JEL Codes: F12; L11; D61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shift effects (C22) | market misallocation (D61) |
| differences in destination-specific marginal utility of income (D11) | shift effects (C22) |
| fundamentals of asymmetric countries (F55) | differences in destination-specific marginal utility of income (D11) |
| rotation effects (C33) | market misallocation (D61) |
| differing markup strategies (D49) | rotation effects (C33) |
| rotation effects (C33) | implications for cutoff productivities, quantities, and welfare (D24) |
| market conditions (P42) | welfare levels in China (I31) |
| global social optimum (D69) | welfare levels in China (I31) |