Economía / Investigaciones y publicaciones / CEDE / Publicaciones / Documentos CEDE / 2005 / International Trade, Migration and Investment with Horizontal Product Differentiation and Free Entry and Exit of Firms

This paper builds on a circular road model of the world with horizontal product
differentiation and free entry and exit of firms, to derive results that can be applied in
industrial organization, international trade and political economy. The model shows
that freer international trade increases welfare -with ideal variety preferencesthrough
the exploitation of economies of scale and better allocative efficiency; that
all participating countries gain from trade, and that smaller countries have more to
win from free trade than larger countries. The model also explains that there may be
adjustment costs when liberalizing trade and thus, political resistance to trade
liberalization. International migration can also be analyzed with the model, showing
the possibility of suboptimal migration flows and political barriers to the exit of
national citizens. The model suggests that foreign direct investment will be welfare
improving for the source country in the short run, and for the receiving country in the
long run. Finally, the model provides a microfoundation for the use of demand
curves with constant and negative slopes.