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This chapter describes how to convert an existing Armington CGE model into a Melitz CGE model with minimal changes to the original Armington model. The main task is to add equations to the bottom of the Armington model to form what we call an Armington-to-Melitz or A2M system. With an A2M system, industries can be switched between Armington and Melitz treatments by closure swaps. We use BasicArmington (a simple Armington model) to explain how to create an A2M system. Then we apply the method to a 10-region, 57-commodity version of the frequently applied policy-oriented GTAP model to create a GTAP-A2M system. Using this system, we compare the effects under Armington and Melitz assumptions of a tariff imposed by North America on imports of wearing apparel (Wap). To facilitate the comparison, we decompose the welfare effects for each region into parts attributable to changes in employment, terms of trade and scale-related efficiency. This helps us to understand how each of these factors operates under Armington and Melitz, but it does not give us an intuitive explanation of their net outcome. To explain net outcomes for welfare effects by region we set out an intuitive overarching theory. We check its validity by back-of-the-envelope (BOTE) calculations using GTAP data items and selected simulation results. BOTE calculations enable us to cut through the maze of complications in CGE models to locate, for any specific result, the essential underlying ingredients. |
