The Number of Goods as a Welfare Variable: A Simplified Graphic Approach

Trade, the Internet, and product innovation have greatly enlarged the number of goods ( N ) in the consumer's choice set. The welfare effect of the growth in N has been extensively discussed in the specialized literature, but very little has filtered down to our textbook models of a competitive equilibrium. These focus on the Pareto-optimal allocation of resources for a given N , avoiding the problem of the optimum number of goods, or the welfare gains when the optimum number is increased through trade. This neglect stems from the limitations of our partial-equilibrium analytical tools—for example, indifference maps in which N is fixed. The authors fill this gap in the Hicksian ordinal revolution by developing new indifference curves that express N as a variable, thus allowing them to estimate the variety gains from trade and the real-income gains as new goods enlarge N and to use new pp curves to provide a graphic description of the optimum number of goods in a competitive economy.