The Simple Analytics of the Melitz Model in a Small Open Economy
In this paper we present a version of the Melitz (2003) model for the case of a small economy and summarize its key relationships with the aid of a simple figure. We then use this figure to provide an intuitive analysis of the implications of asymmetric changes in trade barriers and show that a decline in import costs always benefits the liberalizing country. This stands in contrast to variants of the Melitz model with a freely traded (outside) sector, such as Demidova (2008) and Melitz and Ottaviano (2008), where the country that reduces importing trade costs experiences a decline in welfare.
We thank Arnaud Costinot and Kala Krishna for helpful comments. We also would like to thank Robert Staiger and two anonymous referees for very useful comments and suggestions. All remaining errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Demidova gratefully acknowledges financial support from the Social Sciences and Humanities Research Council of Canada.
“The Simple Analytics of the Melitz Model in a Small Economy” (with Andrés Rodríguez-Clare), Journal of International Economics, July 2013, 90(2), pp. 266-272