Welfare gains in the Armington, Krugman and Melitz models: Comparisons grounded on gravity

Abstract

Under a wide range of model features, we show that in response to a reduction in global trade costs, the global welfare gains are largest in the Melitz model, followed by the Krugman model, and smallest in Armington. Labor‐leisure choice and intermediate goods are the most important features for differentiating results. We show that the optimal tariff is significantly lower in the monopolistic competition models, thereby moving policy away from protectionism. We are the first to consider multi‐sector comparative‐static welfare impacts of these market structures, while maintaining equal trade responses across the models consistent with a shared structural‐gravity elasticity.