The Impact of Variety on World Prices

Krugman (1979) brought the study of varieties into sharp focus by presenting a simple generalequilibrium model in which countries gain from trade through the import of new varieties. Since then, economists have been hampered in their ability to quantify the impact of new varieties on national welfare by the econometric and data hurdles that need to be surmounted. In this paper, we document some stylized facts about the growth in global varieties which suggest that there may have been substantial welfare gains through the import of new varieties. Moreover, we calculate the impact of increased variety on import prices and find that conventional measures of import price inflation may be dramatically biased upward. Classical international-trade theory postulates that the elimination of trade barriers improves welfare by reducing the wedge between domestic and import prices as well as the ensuing deadweight loss. An entirely different reason for the gains from trade arises from models of monopolistic competition. If consumers value variety and countries cannot produce all varieties due to a fixed cost in the production of each variety, countries stand to gain from trade