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Trade Liberalization and Welfare Inequality: a Demand-Based Approach

Tarasov, Alexander (2008): Trade Liberalization and Welfare Inequality: a Demand-Based Approach.

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Abstract

There is strong evidence that different income groups consume different bundles of goods. This evidence suggests that trade liberalization can affect welfare inequality within a country via changes in the relative prices of goods consumed by different income groups (the price effect). In this paper, I develop a framework that enables us to explore the role of the price effect in determining welfare inequality. There are two core elements in the model. First, I assume that heterogenous in income consumers share identical but nonhomothetic preferences. Secondly, I consider a monopolistic competition environment that leads to variable markups affected by trade and trade costs. I find that trade liberalization does affect the prices of different goods differently and, as a result, can benefit some income classes more than others. In particular, I show that the relative welfare of the rich with respect to that of the poor has a hump shape as a function of trade costs.

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