International Trade with Indirect Additivity∗

We develop a general equilibrium theory of monopolistic competition and trade based on indirectly additive preferences and heterogenous firms. The theory generates a new prediction that markups are independent from destination population but increasing in destination per capita income, as documented by the empirical literature. Trade liberal-ization delivers incomplete cost pass-through and the key implication is that the welfare gains from trade are significantly lower than those predicted by theories that feature full pass-through; the gap in welfare increases with firms ’ pricing-to-market elasticities. We outline a tractable parametric specification of indirectly additive preferences that further predicts that small firms grow more during trade liberalization and pass through changes in costs to a higher degree than do large productive ones. We estimate the model’s pa-rameters to match moments from cross-firm and cross-country data and we quantify the welfare cost of autarky as well as the gains from the proposed Transatlantic Trade an