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GTAP Resource #3850

"Deriving the Armington, Krugman and Melitz models of trade"
by Dixon, Peter and Maureen Rimmer

This paper shows how the Arminigton, Krugman and Melitz models of international trade are all specialized versions of a basic model. It is inspired by Balistreri and Rutherford (2012) who set out stylized versions of three models: Armington (1969); Krugman (1980); and Melitz (2003). In their exposition, Balsitreri and Rutherford develop each model separately. This paper draws out connections between the three models by developing them as special cases of a common basic model.

In the basic model, widgets are produced in each country s by an industry containing Ns firms. Consumers in country j treat widgets from different firms around the world as imperfect substitutes. The widget industry in each country s earns zero pure profits. In producing and selling widgets, firms in country s incur three types of costs: variable costs that are proportional to output; fixed setting up costs (Hs) ; and a fixed cost in selling to consumers in country j (Fsj). The two types of fixed costs are the same for all firms in country s.

In the Armington model, the two types of fixed costs are zero. Armington’s firms in country s have identical productivity and behave in a purely competitive manner: that is they perceive the elasticity of demand for their product as ∞. With competitive behaviour and with costs proportional to output, profits for each firm are automatically zero. The number of firms in country s is fixed exogenously. Output variations for the industry are accommodated by output variations for the firms.

In the Krugman model, there are non-zero setup costs, Hs > 0, but zero fixed costs on each trade link, Fsj = 0. Krugman’s firms are monopolistically competitive: their perceived elasticity of demand for their product is the actual elasticity which is finite. All widget firms in country s have the same productivity. The number of firms in country s adjusts endogenously as part of the mechanism of achieving zero pure profits.

Resource Details (Export Citation) GTAP Keywords
Category: 2012 Conference Paper
Status: Published
By/In: Presented at the 15th Annual Conference on Global Economic Analysis, Geneva, Switzerland
Date: 2012
Created: Dixon, P. (4/27/2012)
Updated: Batta, G. (4/30/2012)
Visits: 3,333
No keywords have been specified.

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