Optimality in the Armington, Krugman and Melitz Models

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


Every student of welfare economics is aware of propositions suggesting, perhaps with caveats, that free trade (zero tariffs) in a world of pure competition generates a Pareto optimal or efficient outcome. In this chapter we investigate what can be said about efficiency in the worlds of Krugman and Melitz where industries are monopolistically competitive with prices exceeding marginal costs. We find that the complications introduced by Krugman and Melitz do not prevent free trade from delivering intra-sectoral efficiency: under free trade a Melitz worldwide widget industry satisfies any given levels of widget demands across countries with cost-minimizing worldwide selections of firms, output per firm and trade volumes. However, monopolistic competition in some industries combined with pure competition in others introduces inter-sectoral inefficiency, with possibilities for Pareto improvements by allocating resources away from industries that are purely competitive toward those that are monopolistically competitive. Working with the Dixit–Stiglitz model we show that inter-sectoral welfare costs associated with mixed market structures (pure and monopolistic competition) are likely to be small in an empirical CGE setting. Conclusions reached in this chapter concerning intra and inter-sectoral efficiency are helpful for interpreting results from CGE simulations with Armington, Krugman and Melitz features. For example, Melitz intra-sectoral efficiency with zero tariffs means that envelope theorems are applicable. As we will see in Chaps.  6 and  7, this helps us to understand the circumstances under which Melitz and Armington models produce similar welfare results for the effects of tariff changes.


Intra-sectoral efficiency Inter-sectoral efficiency Welfare in Melitz 


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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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