Armington Meets Melitz: Introducing Firm Heterogeneity in Global CGE Model of Trade

Fan Zhai

No 331646, Conference papers from Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project

Abstract: Traditional CGE models with Armington assumption fail to capture the extensive margin of trade, thereby underestimate the trade and welfare effects of trade opening. To address this problem, this paper introduces the Melitz (2003) theoretical framework with firm heterogeneity and fixed exporting costs into a global CGE model. Some illustrative simulations show that the introduction of firm heterogeneity improves the ability of CGE model to capture the trade expansion and welfare effects of trade liberalization. Under the case of global manufacturing tariff cut, the estimated gains in welfare and exports are more than double of that obtained from standard Armington CGE model. Sensitivity analysis also indicates that model results are sensitive to the shape parameters of firm productivity distribution, suggesting the need of further empirical work to estimate the degree of firm heterogeneity.

Keywords: International Relations/Trade; Research Methods/Statistical Methods (search for similar items in EconPapers)
Pages: 30
Date: 2007
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Journal Article: Armington Meets Melitz: Introducing Firm Heterogeneity in a Global CGE Model of Trade (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:pugtwp:331646

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