Chapter 2 Trade Liberalization and the Extensive Margin of Trade in a CGE Model with Heterogeneous Firms

This chapter presents a global computable general equilibrium model with firm heterogeneity based on the Melitz (2003) framework and examines the relative importance of the intensive and extensive margins in the trade expansion following trade liberalization. Using a set of plausible parameters values suggested by empirical studies and calibrating the model to the recent Global Trade Analysis Project (GTAP) global database, our illustrative simulations indicate that the extensive margin accounts for around one-third of the trade growth induced by a reduction in tariffs or variable trade costs. In the case of reducing fixed trade costs, the extensive margin contributes almost 200 percent of the trade expansion, with the intensive margin contributing negatively to trade growth.