A Computable General Equilibrium Model for Open Economies with Imperfect Competition and Product Differentiation

This paper corrects a shortcoming in the literature on computable general equilibrium models and imperfect competition with free entry and increasing returns to scale. The trade integration simulations applied to the US suggest that the shortcoming is quantitatively insignificant if key conditions are fulfilled. The model also shows how to incorporate iceberg trade costs in both constant and increasing returns to scale sectors. A fall in trade costs can have a large impact on welfare as less resources are wasted. In addition, the same model is proposed for competition policy experiments against illegal collaboration among competitors. The results of the simulations provide interesting insights, showing extraordinarily large welfare gains if competition policies are introduced to break the collusive behaviour in the US market among either domestic firms or foreign firms. However, if these policies are brought in to weaken the collusive behaviour among exporting firms, then a welfare loss can be generated because of a large deterioration of terms of trade.