Armington, Krugman and Melitz as Special Cases of an Encompassing Model

  • Peter B. Dixon
  • Michael Jerie
  • Maureen T. Rimmer
Part of the Advances in Applied General Equilibrium Modeling book series (AAGEM)


This chapter is built around a general, theoretical, multi-country model of production, pricing and trade by firms in the widget industry. We refer to this as the Armington, Krugman, Melitz Encompassing (AKME) model. We explain the Armington, Krugman and Melitz models and the relationships between them by showing that they are successively less restrictive special cases of AKME. All CGE modelers are familiar with the Armington model in which country of origin distinguishes one widget from another and firms play no role. For Krugman and Melitz, widgets are distinguished by firm rather than country. However, before these models can be taken into the CGE framework, the firm dimension must be eliminated. “Typical” firms must replace individual firms. Defining a typical firm in each country for Krugman is straight forward. While different firms produce distinct varieties of widgets, all widget firms in a given country have the same productivity and face the same demand conditions. Consequently, any widget firm in a country will do as typical. For Melitz, there is a richer specification of inter-firm heterogeneity. While firms in a given country face the same demand conditions, they can have different productivity levels. This makes identification of the typical firm challenging. We show how Melitz defines multiple typical firms, one for each trading link. Throughout the chapter we explain the modeling strategy in non-technical terms but we do not shirk the mathematics, particularly for Melitz. Understanding the mathematics is essential for accurate translation of Melitz into the CGE framework and for interpreting results.


Trade models Armington Krugman Melitz Encompassing model 


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Copyright information

© Springer Nature Singapore Pte Ltd. 2018

Authors and Affiliations

  • Peter B. Dixon
    • 1
  • Michael Jerie
    • 1
  • Maureen T. Rimmer
    • 2
  1. 1.Centre of Policy StudiesVictoria UniversityMelbourneAustralia
  2. 2.Centre of Policy StudiesVictoria UniversityMelbourneAustralia

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