Gains from Trade Under Monopolistic Competition

The monopolistic competition model in international trade predicts three sources of gains from trade that are not present in traditional models: consumer gains from having access to new import varieties of differentiated products; gains from a reduction in firm markups due to import competition; and gains from the self‐selection of more efficient firms into export markets, provided that firms are heterogeneous in their productivities. With the added assumption that the distribution of firms’ productivity is Pareto, and with a support that is unbounded above, we argue that only the third source of gains from trade, due to the self‐selection of firms, operates. This result helps to explain the simple formula for the gains from trade found by Arkolakis et al. (2012). If the Pareto distribution is bounded above, however, then all three sources of gains from trade operate once again.