In applied models, the modelling of price formation and market equilibrium at the sector level, is often based on Armington (1969) and Dixit & Stiglitz (1977).
Given the Armington assumption, a price increase will lead to a decline in the sectors exports. If the export elasticity is high (which it typically is in the long run) this will lead to a significant decrease in the sectors’s production.
These assumptions are often characterized as being too simplistic. It is argued that the sector in fact consists of many heterogeneous firms. A higher tax must be expected to force the firms with the lowest productivity out of the market, whereas the firms with high productivity have enough profit to adapt to the higher tax.
The paper describes an Armington model with heterogeneous firms.