The Number of Goods as a Welfare Variable: A Simplified Graphic Approach

Trade, the Internet, and product innovation have greatly enlarged the number of goods ( N ) in the consumer's choice set. The welfare effect of the growth in N has been extensively discussed in the specialized literature, but very little has filtered down to our textbook models of a competitive equilibrium. These focus on the Pareto-optimal allocation of resources for a given N, avoiding the problem of the optimum number of goods, or the welfare gains when the optimum number is increased through trade. This neglect stems from the limitations of our partial-equilibrium analytical tools-for example, indifference maps in which N is fixed. The authors fill this gap in the Hicksian ordinal revolution by developing new indifference curves that express N as a variable, thus allowing them to estimate the variety gains from trade and the real-income gains as new goods enlarge N and to use new pp curves to provide a graphic description of the optimum number of goods in a competitive economy.