Endogenous variety and the gains from trade

We explore the implications of models with increasing returns, endogenous variety and rm-level heterogeneity for the quanti\u85cation of the gains from trade. We \u85rst focus on the impact of trade liberalization on imported variety by analyzing the experience of Costa Rica from 1986 to 1992. We \u85nd that although liberalization triggered a sizable increase in variety, the resulting welfare gains were small because of strong heterogeneity across imported goods. Upon trade liberalization, the new varieties are imported in small quantities, and hence contribute little to welfare. We then present a model with \u85rm-level increasing returns, di¤erentiated goods, monopolistic competition, endogenous variety and free entry to show that total variety (domestic plus imported) can either increase, decrease or remain constant with trade liberalization. More importantly, the gains from trade do not depend on what happens to total variety. In fact, we \u85nd that, conditional on the estimated elasticities of trade with respect to trade costs, models with increasing returns, endogenous variety, free or restricted entry, and \u85rm-level heterogeneity have exactly the same implications for welfare gains from trade liberalization as traditional models. We thank Kala Krishna for encouraging us to write this paper. We bene\u85ted from comments by participants at the AEA Session on "Firm Heterogeneity and International Trade. " All errors are our own.