Implementing a computable general equilibrium model with heterogenous firms and endogenous productivity

Abstract

This paper presents a computable general equilibrium model with trade-induced effects on industrial productivity and firm heterogeneity, based on Melitz (2003). Unlike the standard setting, our model considers multiple primary resources, different technologies, intermediate factors and input-output linkages. Implementation issues and calibration techniques are discussed. The inclusion of industries with heterogeneous firms in a CGE framework does not simply make the Melitz model 'operational', but allows accounting for structural effects that affect the nature, meaning and implications of the results. We illustrate the point through a numerical example, in which a standard neoclassic, a Melitz and a hybrid models are compared. The results show that the hybrid model displays the largest welfare gains from lower trade barriers, as it combines Ricardian comparative advantages with Melitz average productivity improvements. However, they also show that new effects, not present in the original Ricardo and Melitz frameworks, are at a work.