Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/237979 
Year of Publication: 
2020
Series/Report no.: 
BGPE Discussion Paper No. 188
Publisher: 
Friedrich-Alexander-Universität Erlangen-Nürnberg, Erlangen und Nürnberg
Abstract: 
We set up a trade model with two countries, two sectors, and one production factor, which features a home-market effect due to the existence of trade costs. We consider search frictions and firm-level wage bargaining in the sector producing differentiated goods and a perfectly competitive labor market in the sector producing a homogeneous good. Consumers have price-independent generalized-linear preferences over the two types of goods, covering homothetic and quasilinear preferences as two limiting cases. We show that trade between two countries that differ in their population size leads to an expansion of the differentiated goods sector and a contraction of the homogeneous good sector in the larger economy. This induces the larger country to net-export differentiated goods at the cost of a higher economy-wide rate of unemployment in the open economy (with the effects reversed for the smaller country). The welfare effects of trade depend on the preference structure. Looking at the two limiting cases, we show that the larger country is likely to benefit from trade if preferences are homothetic, whereas losses from trade are possible if preferences are quasilinear. The opposite is true in the smaller country. This reveals an important role of preferences for the welfare effects of trade in the presence of labor market imperfection, a result we further elaborate on in two extensions, in which we consider more general preferences and differences of countries in their per-capita income levels.
Subjects: 
Preferences
Search frictions
Wage bargaining
Trade structure
Welfare and employment effects
JEL: 
F12
F15
F16
D11
Document Type: 
Working Paper

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