An Empirical Analysis of US-Japan Trade Agreement on Welfare in ‘New’ and ‘New New’ Trade models of Monopolistic Competition and Firm Heterogeneity

Abstract

The perfectly competitive Armington’s model underestimates the welfare effects of the US-Japan Trade Agreement, whereas the monopolistically competitive Krugman "New" trade model will have positive scale effects. As trade begins in firm heterogeneity Melitz "New New" trade model, only the most competitive firms can survive. Although the Melitz model has negative variety and fixed cost effects, the larger positive technology and scale effects offset the negative effects. Thus, the total welfare gains in the Melitz (2003) model owing to production technology and scale effects are much larger than those in the Armington (1969) and Krugman (1979) models. The total welfare gains in the Melitz (2003) model are also larger than those in the Armington (1969) model because of the scale effect of the US-Japan Trade Agreement. Thus, the welfare effects depend on the economic structure of the free-trade agreement members. However, we need to adopt the more realistic Melitz "New New" trade model and Krugman "New"trade model than the standard conventional Armington model to analyze the more plausible economic effects of the US- Japan Trade Agreement.