Benefits of trade in the presence of transactions costs

The main stream of traditional economists asserts that trade liberalization benefits each of the countries involved. This is argued under the extreme assumption of zero transactions costs in both the domestic markets of the trading partners and the world market. Different social and economic regimes incorporate different institutions of exchange. The differences are prominent between predominantly informal economies and formal economies. Opening up borders to formal economies generally causes formalization of exchange institutions in the informal economy, which necessitates an increase in transactions costs.; This dissertation seeks to illustrate the plausibility that the gains from free trade will be adjusted by the increase in transactions costs as a result of formalization. It first develops a practical methodology for directly measuring transactions costs for an economy. It then applies that methodology to the 1992 U.S. and 1975 Mexican data and provides a comparison of the level of transactions costs between these two countries. Next, this dissertation formulates an applied general equilibrium framework in which transactions costs incurred by producers and final demanders are explicitly represented. The model is calibrated to the stylized facts of the 1975 Mexican economy. Based on the specified parameter values, counterfactual equilibrium analyses for alternative scenarios of exchange institution formalization are performed. In each scenario the impact of trade liberalization on social welfare and other economic variables is investigated.; The simulation results suggest that the benefits of free trade accruing to a predominantly informal economy as a result of trade liberalization could be smaller when the formalization of institutions and the associated increase in transactions costs are taken into consideration.