Gains from trade and efficiency under monopolistic competition: a variable elasticity case

We present a general equilibrium model of monopolistic competition with variable demand elasticities and investigate the impact of free trade on welfare and efficiency. First, contrary to the constant elasticity case, in which all gains from trade are due to increasing product diversity, our model features gains from pro-competitive effects. Second, we show that the market outcome is not constrained efficient because too many firms operate at an inefficiently small scale. Last, we prove that free trade raises efficiency by narrowing the gap between the equilibrium utility and the constrained optimal utility.