A Conjectural Variation Computable General Equilibrium Model with Free Entry

This paper proposes a procedure to incorporate the conjectural variation approach in Computable General Equilibrium (CGE) analysis such that the strategic interaction among rival firms in international markets can be modelled. It shows how to calibrate the conjectured reactions of rival domestic and foreign firms. It also shows that the approach suggested by Harrison, Rutherford and Tarr (henceforth, HRT) is valid if Cournot competition prevails among domestic firms, among foreign firms, and between domestic and foreign firms. A conjectural variation CGE model applied to Turkey indicates that, if Cournot competition prevails between domestic and foreign firms, the results obtained under the HRT approach are very similar to those obtained under the conjectural variation approach. However, if foreign firms expect that rival domestic firms would react to their own action, then the results change dramatically. In a more competitive context, a large welfare gain from trade liberalisation can be generated.