Factor Structure and Market Integration under Two-Factor Monopolistic Competition Model

The authors study the impact of trade liberalization on the market of a differentiated good and consumers’ welfare. The economy involves two factors of production: labor and capital. The researchers find that consumers always gain from trade liberalization. The article also establishes that the behavior of equilibrium price is independent of factor endowments’ structure in the countries involved into trade. The equilibrium price decreases (increases, remains unchanged) under trade liberalization if and only if the inverse demand elasticity is increasing (decreasing, constant) with respect to the individual consumption level. Furthermore, firms’ size which are measured as output increases (decreases) when autarky changes to free trade if and only if the country is relatively richer (poorer) in capital than its trading partner, regardless of the demand-side properties of the economy. Finally, the behavior of capital price (which equals firms’ profits in equilibrium) is more complicated in the general case, but can be fully characterized for two limiting cases: (i) when the structure of factor endowments in both countries is the same, and (ii) when the Foreign country is a periphery country, i.e. it has zero endowment of capital.