Optimal trade policy with monopolistic competition and heterogeneous firms

Jan I. Haaland, Anthony J. Venables

Research output: Contribution to journalArticleResearchpeer-review

13 Citations (Scopus)


This paper derives optimal trade and domestic taxes for a small open economy containing a monopolistically competitive (MC) sector in which firms may have heterogeneous productivity levels. Analysis encompasses cases in which the domestic MC sector is able to expand or contract flexibly, or is constrained to be of fixed size. In the former case domestic protection can bring gains by increasing the number of product varieties on offer; these gains (and the corresponding rates of domestic subsidy or of import tariffs) are reduced by heterogeneity of foreign exporters some of whom may withdraw from the market. In the latter case gains from protection arise from terms-of-trade effects; since various margins of substitution are switched off, only the relative values of domestic taxes, import tariffs and export taxes matter. In general, policies work through both a terms-of-trade and a variety effect, and the paper shows how the relative importance of each depends on the structure of the economy.

Original languageEnglish
Pages (from-to)85-95
Number of pages11
JournalJournal of International Economics
Publication statusPublished - Sep 2016
Externally publishedYes


  • Heterogeneous firms
  • Monopolistic competition
  • Productivity
  • Terms of trade
  • Trade policy
  • Variety

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