Trade in Intermediate Goods in a Model with Monopolistic Competition

Abstract

A model of trade in intermediate and final goods is developed incorporating the features of increasing returns and monopolistic competition. It is shown that the endowment basis (comparative advantage) for trade becomes crucial in determining trade across stages of production, with the capital‐rich country a net exporter of specialized intermediate inputs and an importer of the final good. The capital‐rich country is shown to be immune to distributional conflicts, whereas for the labour‐rich country the distributional conflict crucially hinges upon the elasticity of substitution between intermediate inputs. Thus, free trade has inherently asymmetric effects on the functional distribution of income for countries differing in labour–capital ratios.