Computable General Equilibrium (CGE) Models: A Short...

Computable General Equilibrium (CGE) Models:A Short Course

HodjatHodjat GhadimiGhadimiRegional Research InstituteRegional Research Institute

WWW.RRI.WVU.EDUWWW.RRI.WVU.EDU

Spring 2007Spring 2007

Session Two: SPECIFICATIONSession Two: SPECIFICATION

http://www.rri.wvu.edu/

Session Two: SpecificationSession Two: Specification GhadimiGhadimi 2007; Regional Research Institute 2007; Regional Research Institute

Session 2:Session 2: SpecificationSpecification

A taxonomy of modelsA taxonomy of modelsComponents of a simple CGEComponents of a simple CGEMathematical model statementMathematical model statement

Session Two: SpecificationSession Two: Specification Ghadimi 2007; Regional Research Institute Ghadimi 2007; Regional Research Institute

Review: CGE KeywordsReview: CGE Keywords

MultisectoralMultisectoralNonlinearNonlinearEconomyEconomy--widewideAutonomous decision makingAutonomous decision makingWalrasianWalrasian competitive equilibriumcompetitive equilibrium


Circular Flow of IncomeCircular Flow of Income

GOVERNMENT

FACTORMARKET

PRODUCTMARKET

CAPITALMARKET

HOUSEHOLDPRODUCERS

REST OF THEWORLD

FACTOR PAYMENTSPAYMENTS TO CAPITAL AND LABOR

OIL REVENUES

INCOME TAX

INTERMEDIATE INPUTS

INDIRECT TAXES

DEPRECIATION

INVESTMENTSPRIVATE SAVINGS

GOV. SAVINGS

CONSUMPTION

GOV. CONSUMPTION

EXPORTS

IMPORTS

PAYMENTS TO GOODS & SERVICES

FOREIGN SAVINGS

Structure of a CGE modelStructure of a CGE model

A taxonomy of modelsA taxonomy of models


Models and Policy AnalysisModels and Policy Analysis

Policy makers intend to change the way Policy makers intend to change the way the economy operates, rather than just the economy operates, rather than just understand itunderstand itPolicy analysis: explain the links between Policy analysis: explain the links between instruments and targetsinstruments and targetsModelModel--building: the process of abstraction building: the process of abstraction and generalization required to provide and generalization required to provide structure to our empirical observationstructure to our empirical observation



Economic ModelsEconomic Models

Analytic modelsAnalytic modelsStylized numerical modelsStylized numerical modelsApplied modelsApplied models



Apply theoretical framework & statistical methods to filter out inessential details

Focus on important assumptions &causal mechanisms

Attach numbers to the variables & relate them to economic performance

Include more details, more specific

Complex Real World

Conceptual Model(Stylized facts)

Analytical Model

Stylized Model

Applied Model



Complex Real World

Conceptual Model(Stylized facts)

Analytical Model

Stylized Model

Applied Model


Description of reality

StrategicPolicy Analysis

DetailedPolicy Analysis


Analytic modelsAnalytic models

Cast economic relationships into a form Cast economic relationships into a form susceptible to mathematical analysissusceptible to mathematical analysisExplore the implications of various sets of Explore the implications of various sets of postulatespostulatesDeliberately simplified to focus on Deliberately simplified to focus on important assumptions and causal important assumptions and causal mechanisms mechanisms Empirical realism not an important Empirical realism not an important criterioncriterion



Stylized numerical modelsStylized numerical modelsAttach numbers to the variables and relate Attach numbers to the variables and relate them to economic statisticsthem to economic statisticsLarger, more complex & more realisticLarger, more complex & more realisticUsed to analyze problems too difficult to Used to analyze problems too difficult to solve analyticallysolve analyticallyEmpirical, able to explore the size of Empirical, able to explore the size of various effectsvarious effectsGive up simplicity to gain in applicability & Give up simplicity to gain in applicability & generalitygenerality



Applied modelsApplied models

Include broader range of stylized factsInclude broader range of stylized factsMore specific and narrow in applicationMore specific and narrow in applicationInclude more institutional detailsInclude more institutional detailsAdditional details may obscure the major Additional details may obscure the major causal mechanisms without adding any causal mechanisms without adding any empirically significant effectsempirically significant effects



CGE models fall into both stylized and CGE models fall into both stylized and applied categoriesapplied categoriesIn addition CGE models:In addition CGE models:

Have strong links with basic economic theoryHave strong links with basic economic theoryWork by simulating the interaction of various Work by simulating the interaction of various actors as specified in neoclassical generalactors as specified in neoclassical general--equilibrium theoryequilibrium theoryDerive Derive ““behaviorbehavior”” based on optimization as based on optimization as specified in microspecified in micro--theorytheoryAre fully Are fully ““closedclosed”” in that the supply and in that the supply and demand sides of all markets are specifieddemand sides of all markets are specified



Components of a simple CGEComponents of a simple CGE

See a SAM structureSee a SAM structure


Mathematical model statementMathematical model statement

123 Model123 ModelGraphical AnalysisGraphical AnalysisEquations of an applied modelEquations of an applied model


Capture mechanisms by which external Capture mechanisms by which external shocks and domestic policies ripple shocks and domestic policies ripple through the economythrough the economyMany problems (and solutions) are related Many problems (and solutions) are related to links between external sectors and to links between external sectors and domestic economydomestic economyBased on: Based on: DevarajanDevarajan--GoGo--LewisLewis--RonbinsonRonbinson--SinkoSinko (1997)(1997)

11--22--3 Model3 Model




1 country, 2 activities, 3 commodities1 country, 2 activities, 3 commodities2 activities, producing D and E.2 activities, producing D and E.

E not consumed domestically.E not consumed domestically.

Additional commodity, M, consumed Additional commodity, M, consumed domestically but not produced.domestically but not produced.



Very simplistic stylized model, but:Very simplistic stylized model, but:Mechanisms are transparentMechanisms are transparentCan be solved graphically, analytically, or with Can be solved graphically, analytically, or with ExcelExcelBehavior is similar to that of more complex Behavior is similar to that of more complex modelsmodels





Aggregate GDP (X) is fixed.Aggregate GDP (X) is fixed.Full employment model. Full employment model.

Trade balance set exogenously.Trade balance set exogenously.World prices of M and E are fixed.World prices of M and E are fixed.Total absorption (Q) is endogenous.Total absorption (Q) is endogenous.



Basic 1Basic 1--22--3 CGE Model3 CGE Model

( )( )

( )

( )

2

2

Flows

1. , ;

2. , ;

3.

4. ,

5. ,

6.

S

S D

Dq

e dS

m dD

x

X G E D

Q F M D

YQP

E g P PDM f P PDY P X R B

σ

= Ω

=

=

=

=

= +

( )( )

1

1

Prices7. 8.

9. ,

10. ,

11. 1Equilibrium Conditions12. 013. 014.

m m

e e

x e d

q m d

D S

D S

m e

P R pwP R pw

P g P P

P f P P

R

D DQ Qpw M pw E B

=

=

=

=

≡

− =

− =

− =




Identities15. 16. 17.

x e d S

q S m d D

q D

P X P E P DP Q P M P DY P Q

≡ +

≡ +

≡




Endogenous VariablesEndogenous VariablesE: Export goodE: Export goodM: Import goodM: Import goodDDSS: Supply of domestic good: Supply of domestic goodDDDD: Demand for domestic good: Demand for domestic goodQQSS: Supply of composite good: Supply of composite goodQQDD: Demand for composite good: Demand for composite goodY: Total incomeY: Total incomePPee: Domestic price of export good: Domestic price of export goodPPmm: Domestic price of import good: Domestic price of import goodPPdd: Domestic price of domestic : Domestic price of domestic

goodgood

PPxx: Price of aggregate output: Price of aggregate outputPPqq: Price of composite good: Price of composite goodR: Exchange rateR: Exchange rate

Exogenous VariablesExogenous Variablespwpwee: world price of export good: world price of export goodpwpwmm: world price of import good: world price of import goodB: Balance of tradeB: Balance of tradeσσ: Import substitution elasticity: Import substitution elasticityΩΩ: Export transformation : Export transformation

elasticityelasticity



SAM for 1SAM for 1--22--3 Model3 Model

Activities Commod Hshld World Activities d DP D eP E Commodities q DP Q Households xP X R B World mP M Total d S eP D P E+ q SP Q Y


E/D = k (PE / PD ) Ω

PE = R·pwe

PD /PE

D

E



M/D = kM/D = k’’(P(PD D / P/ PMM))σσ

PPMM = R= R··pwmpwm

PD /PM

M

D



11--22--3 Programming Model3 Programming Model

( )

( ) x

Maximize , ;

with respect to: , , ,subject to: Shadow Prices

1. , ; technology /

2.

D S

S x q

Q F M D

M E D D

G E D X P P

σ

λ

=

Ω ≤ =

balance of trade /3. domestic market /

m e b q

D S d d q

pw M pw E B R PD D P P

λ

λ

⋅ ≤ ⋅ + =

≤ =



PPDD/P/PEE

PMM=PEEPPDD/P/PMM

E

D

M

D

11--22--3 3 ModelModel



11--22--3 CGE Model with 3 CGE Model with Consumption, Government, Consumption, Government,

and Investmentand Investment

Shantayanan DevarajanShantayanan DevarajanDelfin S. GoDelfin S. Go

Jeffrey D. LewisJeffrey D. LewisSherman RobinsonSherman Robinson

Pekka SinkoPekka Sinko



11--22--3 CGE Model3 CGE Model

( )( )

( )

( )

2

2

Real Flows

1. , ;

2. , ;

3.

4. ,

5. ,

S

S D

D

e dS

m dD

X G E D

Q F M D

Q C Z GE g P P

DM f P PD

σ

= Ω

=

= + +

=

=




( )

6. 7. 8.

9. 1

m m

q q D

y

e e

x q

g

t y

T t R pw Mt P Qt Yt P E

Y P X tr P re RS s Y R B S

C P s t Y

=

+

+

+

= + +

= + +

= − −




( )( )( )

( )( )

1

1

Prices

10. 1

11. 1

12. 1

13. ,

14. ,

15. 1

m m m

e e e

t q q

x e d

q m d

P t R pw

P t R pw

P t P

P g P P

P f P P

R

= +

+ =

= +

=

=

≡




Equilibrium Conditions16. 017. 018. 19. 020. 0

D S

D S

m e

t

q q g

D DQ Qpw M pw E ft re BP Z ST P G tr P ft R S

− =

− =

− − − =

− =

− − + − =




Identities21. 22.

x e d S

q S m d D

P X P E P DP Q P M P D

≡ +

≡ +



Endogenous Variables E: Export good M: Import good DS: Supply of domestic good DD: Demand for domestic good QS: Supply of composite good QD: Demand for composite good Pe: Domestic price of export good Pm: Domestic price of import good Pd: Domestic price of domestic good Px: Price of aggregate output Pq: Price of composite good Pt: Sale price of composite good R: Exchange rate T: Tax revenue Sg: Government savings Y: Total income C: Aggregate consumption S: Aggregate savings Z: Aggregate real investment

Exogenous Variables pwe: world price of export good pwm: world price of import good tm: Tariff rate tx: Export tax rate tq: Sales tax rate ty: Direct tax rate tr: Government transfers (real) ft: Foreign transfers to government re: Foreign remittances to private sector s: Average savings rate X: Aggregate output (GDP) G: Real government demand B: Balance of trade σ: Import substitution elasticity Ω: Export transformation elasticity


IRAN CGEIRAN CGE


Signals: prices in a market economySignals: prices in a market economy

K(R)

L(WA)

RS

V(PV)

N(PN)

XD(PX)

E(PE)

XXD(PD)

X(P)

M(PM)

COBB-DOUGLAS

LEONTIEF

CET

CES

Structure of a CGE modelStructure of a CGE model

Computable General Equilibrium (CGE) Models: A Short...

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