CoPS/IMPACT Working Paper Number G-284

Title: Melitz in GTAP Made Easy: The A2M Conversion Method and Result Interpretation

Authors: P.B. Dixon and M.T. Rimmer


Since the 1970s the Armington approach has been the workhorse specification of trade in CGE models. Under Armington, agents substitute between products from different countries. Conceptually, Melitz provides a more attractive approach in which substitution is between products from different firms, rather than countries. Other attractive features of Melitz are allowance for: monopolistic competition; and economies of scale from fixed establishment costs for firms and fixed set-up costs on trade links. In this paper we show how an Armington model can be converted to Melitz by adding a few equations and introducing closure swaps, with little change to existing code. We apply our Armington-to-Melitz method to the Armington-based GTAP model to derive GTAP-A2M. Then we show how results from a CGE model with Melitz industries can be interpreted and justified via back-of-the-envelope calculations. Finally, we review the strengths and weaknesses of GTAP-HET, an alternative Melitz-based version of GTAP.

JEL classification: C68; D58; F12

Keywords: heterogeneous firms; Armington to Melitz; GTAP-A2M; GTAP-HET; result interpretation

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