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Modern Trade Theory for CGE Modelling: The Armington, Krugman and Melitz Models

Dixon, Peter, Jerie, Michael and Bleazby, Maureen (2016) Modern Trade Theory for CGE Modelling: The Armington, Krugman and Melitz Models. Journal of Global Economic Analysis, 1 (1). 1 - 110. ISSN 2377-2999

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Abstract

This paper is for CGE modelers and others interested in modern trade theory. The Armington specification of trade, assuming country-level product differentiation, has been central to CGE modelling for 40 years. Starting in the 1980s with Krugman and more recently Melitz, trade theorists have preferred specifications with firm-level product differentiation. We draw out the connections between the Armington, Krugman and Melitz models, deriving them as successively less restrictive special cases of an encompassing model. We then investigate optimality properties of the Melitz model, demonstrating that a Melitz general equilibrium is the solution to a global, cost-minimizing problem. This suggests that envelope theorems can be used in interpreting results from a Melitz model. Next we explain the Balistreri-Rutherford decomposition in which a Melitz general equilibrium model is broken into Melitz sectoral models combined with an Armington general equilibrium model. Balistreri and Rutherford see their decomposition as a basis of an iterative approach for solving Melitz general equilibrium models. We see it as a means for interpreting Melitz results as the outcome of an Armington simulation with additional shocks to productivity and preferences variables. With CGE modelers in mind, we report computational experience in solving a Melitz general equilibrium model using GEMPACK.

Item Type: Article
Uncontrolled Keywords: Armington; Krugman and Melitz; CGE modelling; international trade
Subjects: FOR Classification > 1402 Applied Economics
Faculty/School/Research Centre/Department > Centre of Policy Studies (CoPS)
Depositing User: Symplectic Elements
Date Deposited: 28 Sep 2017 05:52
Last Modified: 31 Aug 2018 09:50
URI: http://vuir.vu.edu.au/id/eprint/34705
DOI: https://doi.org/10.21642/JGEA.010101AF
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