Partial Equilibrium Modelling with Heterogeneous Firms: A Framework for UK Trade Policy

Firm heterogeneity plays an important role in shaping a country's trade dynamics, technological change, and economic growth. Evidence suggests that it is larger and higher-performing firms which typically engage in international trade, contributing to a country’s comparative advantage, while lowerperforming firmsfocus more on domestic markets. In good part this is likely to be driven by differences in costs and scale. Changes in costs of trade thus impact differentially on firms. The aim of this paper is to examine this in the context of a partial equilibrium simulation modelling framework, which allows for firm-level heterogeneity. Building upon existing partial equilibrium modelling, we allow for firm level heterogeneity enabling the modelling of firm entry and exit from domestic and export markets in response to trade policy changes. Despite challenges in endogenous firm modelling, particularly the demand for firm-level data and entry cost metrics, this paper aims to overcome obstacles by implementing the model on real-world data for the UK. The paper aims to illustrate how PE modelling can provide a useful tool for analysing and shaping trade policies, contributing to informed decision-making.