Product differentiation and the treatment of foreign trade in computable general equilibrium models of small economies

Abstract

This paper examines the treatment of exports and imports, and external closure rules, adopted in recent single-country computable general equilibrium models of small economies. The paper presents a simple, one-sector analytic model which captures the major features of the multi-sector counterpart used in applied models. The paper derives graphical and algebraic solutions to the model and shows that, unlike some earlier external closures, this one gives rise to a well-behaved, price-taking economy. The model is also useful to illustrate the role of elasticities in popular trade-theoretic models that include traded and non-traded goods.