Commodity Trade Matters

Primary commodities are used as inputs into all production processes, yet they account for approximately 16 percent of world trade. Despite their share in trade, we show that the aggregate gains from trade are largely understated if we ignore key features of commodities: low price elasticities of demand (difficulty in finding substitutes), low price elasticities of supply, and high dispersion of natural resources across countries. We develop a general-equilibrium model of consumption, production, and input-output linkages that explicitly accounts for these features. Our simulations confirm that the gains from trade are significantly larger, especially when considering large trade cost changes.