Representative Firm Exposition of the Firm Heterogeneity Model

12  June 2014    4:00 pm CEST

Eddy Bekkers (with Joseph Francois), JKU

In cooperation with:


wiiw, Rahlgasse 3, 1060 Vienna, lecture hall (entrance from the ground floor)


We show that the Ethier-Krugman monopolistic competitionmodel and the Melitz firm heterogeneity model can be defined as anArmington model with generalized marginal costs and generalized tradecosts. As already known in the literature in both the Ethier-Krugmanmodel and the Melitz model generalized marginal costs are a functionof the amount of factor input bundles. In the Melitz model generalizedmarginal costs are also a function of the price of the factor inputbundles. Lower factor prices raise the number of firms that can enterthe market profitably (extensive margin), reducing generalizedmarginal costs of a representative firm. For the same reason theMelitz model features a demand externality: in a larger market morefirms can enter. The different models are simulated employing theArmington representation using GTAP trade data on 109 countries. It isshown that the outcomes of the Melitz model are exactly identical tothe outcomes of the Ethier-Krugman model if the firm size distributionis granular. The Armington representation of the firm heterogeneitymodel is in particular useful for multisector CGE models.

Keywords: Firm Heterogeneity, CGE Model, Demand Externality

JEL classification: F12