Trade Liberalization and Welfare Inequality: A Demand-Based Approach

There is strong evidence suggesting that different income groups consume different bundles of goods. Hence, trade liberalization can affect welfare inequality via changes in the relative prices of goods consumed by different income groups (the price effect). In this paper, I develop a framework that enables us to explore the role of the price effect in determining welfare inequality. I find that trade liberalization does benefit some income classes more than others. In particular, I show that the relative welfare of the rich with respect to that of the poor has a hump shape as a function of trade costs.