Computable general equilibrium
Encyclopedia
Computable general equilibrium (CGE) models are a class of economic models that use actual economic data to estimate how an economy might react to changes in policy, technology or other external factors. CGE models are also referred to as AGE (applied general equilibrium
) models.
paradigm. For example, they may allow for:
A CGE model database consists of:
CGE models are descended from the input-output models pioneered by Wassily Leontief
, but assign a more important role to prices. Thus, where Leontief assumed that, say, a fixed amount of labour was required to produce a ton of iron, a CGE model would normally allow wage levels to (negatively) affect labour demands.
CGE models derive too from the models for planning the economies of poorer countries constructed (usually by a foreign expert) from 1960 onwards. Compared to the Leontief model, development planning models focussed more on constraints or shortages—of skilled labour, capital, or foreign exchange.
CGE modelling of richer economies descends from Leif Johansen's 1960 MSG model of Norway, and the model developed by the
Cambridge Growth Project in the UK. Both models were pragmatic in flavour, and were dynamic (traced variables through time). The Australian MONASH model is a modern representative of this class. Perhaps the first CGE model similar to those of today was that of Taylor and Black (1974).
CGE models are useful whenever we wish to estimate the effect of changes in one part of the economy upon the rest. For example, a tax on flour might affect bread prices, the CPI, and hence perhaps wages and employment. They have been used widely to analyse trade policy. More recently, CGE has been a popular way to estimate the economic effects of measures to reduce greenhouse gas emissions.
CGE models always contain more variables than equations—so some variables must be set outside the model. These variables are termed exogenous; the remainder, determined by the model, are called endogenous. The choice of which variables are to be exogenous is called the model closure, and may give rise to controversy. For example, some modellers hold employment and the trade balance fixed; others allow these to vary. Variables defining technology, consumer tastes, and government instruments (such as tax rates) are usually exogenous.
Today there are many CGE models of different countries. One of the most well-known CGE models is global: the GTAP
model of world trade.
CGE models are useful to model the economies of countries for which time series
data are scarce or not relevant (perhaps because of disturbances such as regime changes). Here, strong, reasonable, assumptions embedded in the model must replace historical evidence. Thus developing economies are often analysed using CGE models, such as those based on the IFPRI template model .
: they model the reactions of the economy at only one point in time. For policy analysis, results from such a model are often interpreted as showing the reaction of the economy in some future period to one or a few external shocks or policy changes. That is, the results show the difference (usually reported in percent change form) between two alternative future states (with and without the policy shock). The process of adjustment to the new equilibrium is not explicitly represented in such a model, although details of the closure (for example, whether capital stocks are allowed to adjust) lead modellers to distinguish between short-run and long-run equilibria.
By contrast, dynamic CGE models explicitly trace each variable through time—often at annual intervals. These models
are more realistic, but more challenging to construct and solve—they require for instance that future changes are predicted for all exogenous variables, not just those affected by a possible policy change. The dynamic elements may arise from partial adjustment processes or from stock/flow accumulation relations: between capital stocks and investment, and between foreign debt and trade deficits.
Recursive-dynamic CGE models are those that can be solved sequentially (one period at a time). They assume that behaviour depends only on current and past states of the economy. Alternatively, if agents' expectations depend on the future state of the economy, it becomes necessary to solve for all periods simultaneously, leading to full multi-period dynamic CGE models.
Within the latter group dynamic stochastic general equilibrium
models explicitly incorporate uncertainty about the future.
that particular model. Models were expensive to construct, and
sometimes appeared as a 'black box' to outsiders.
Today most CGE models are formulated and solved
using one of the GEMPACK
or GAMS
software systems. Use of such systems has lowered the cost of entry to CGE modelling; allowed model simulations to be independently replicated; and increased the transparency of the models.
Applied general equilibrium
In mathematical economics, applied general equilibrium models were pioneered by Herbert Scarf at Yale University in 1967, in two papers, and a follow up book with Terje Hansen in 1973, with the aim of empirically estimating the Arrow–Debreu general equilibrium model with empirical data, to provide...
) models.
Overview
A CGE model consists of (a) equations describing model variables and (b) a database (usually very detailed) consistent with the model equations. The equations tend to be neo-classical in spirit, often assuming cost-minimizing behaviour by producers, average-cost pricing, and household demands based on optimizing behaviour. However, most CGE models conform only loosely to the theoretical general equilibriumGeneral equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
paradigm. For example, they may allow for:
- non-market clearing, especially for labour (unemployment) or for commodities (inventories)
- imperfect competition (e.g., monopoly pricing)
- demands not influenced by price (e.g., government demands)
- a range of taxes
- externalities, such as pollution
A CGE model database consists of:
- tables of transaction values, showing, for example, the value of coal used by the iron industry. Usually the database is presented as an input-output table or as a social accounting matrixSocial accounting matrixA Social Accounting Matrix represents flows of all economic transactions that take place within an economy . It is at the core, a matrix representation of the National Accounts for a given country, but can be extended to include non-national accounting flows, and created for whole regions or area...
. In either case, it covers the whole economy of a country (or even the whole world), and distinguishes a number of sectors, commodities, primary factors and perhaps types of household. - elasticities: dimensionless parameters that capture behavioural response. For example, export demand elasticities specify by how much export volumes might fall if export prices went up. Other elasticities may belong to the Constant Elasticity of SubstitutionConstant Elasticity of SubstitutionIn economics, Constant elasticity of substitution is a property of some production functions and utility functions.More precisely, it refers to a particular type of aggregator function which combines two or more types of consumption, or two or more types of productive inputs into an aggregate...
class. Amongst these are Armington elasticitiesArmington elasticityAn Armington elasticity is an economic parameter commonly used in models of consumer theory and international trade. It represents the elasticity of substitution between products of different countries, and is based on the assumption made by Paul Armington in 1969 that products traded...
, which show whether products of different countries are close substitutes, and elasticities measuring how easily inputs to production may be substituted for one another. Expenditure elasticitiesIncome elasticity of demand (YED)In economics, income elasticity of demand measures the responsiveness of the demand for a good to a change in the income of the people demanding the good, ceteris paribus. It is calculated as the ratio of the percentage change in demand to the percentage change in income...
show how household demands respond to income changes.
CGE models are descended from the input-output models pioneered by Wassily Leontief
Wassily Leontief
Wassily Wassilyovich Leontief , was a Russian-American economist notable for his research on how changes in one economic sector may have an effect on other sectors. Leontief won the Nobel Committee's Nobel Memorial Prize in Economic Sciences in 1973, and three of his doctoral students have also...
, but assign a more important role to prices. Thus, where Leontief assumed that, say, a fixed amount of labour was required to produce a ton of iron, a CGE model would normally allow wage levels to (negatively) affect labour demands.
CGE models derive too from the models for planning the economies of poorer countries constructed (usually by a foreign expert) from 1960 onwards. Compared to the Leontief model, development planning models focussed more on constraints or shortages—of skilled labour, capital, or foreign exchange.
CGE modelling of richer economies descends from Leif Johansen's 1960 MSG model of Norway, and the model developed by the
Cambridge Growth Project in the UK. Both models were pragmatic in flavour, and were dynamic (traced variables through time). The Australian MONASH model is a modern representative of this class. Perhaps the first CGE model similar to those of today was that of Taylor and Black (1974).
CGE models are useful whenever we wish to estimate the effect of changes in one part of the economy upon the rest. For example, a tax on flour might affect bread prices, the CPI, and hence perhaps wages and employment. They have been used widely to analyse trade policy. More recently, CGE has been a popular way to estimate the economic effects of measures to reduce greenhouse gas emissions.
CGE models always contain more variables than equations—so some variables must be set outside the model. These variables are termed exogenous; the remainder, determined by the model, are called endogenous. The choice of which variables are to be exogenous is called the model closure, and may give rise to controversy. For example, some modellers hold employment and the trade balance fixed; others allow these to vary. Variables defining technology, consumer tastes, and government instruments (such as tax rates) are usually exogenous.
Today there are many CGE models of different countries. One of the most well-known CGE models is global: the GTAP
GTAP
GTAP is a global network of researchers who conduct quantitative analysis of international economic policy issues, especially trade policy. They cooperate to produce a consistent global economic database, covering many sectors and all parts of the world...
model of world trade.
CGE models are useful to model the economies of countries for which time series
Time series
In statistics, signal processing, econometrics and mathematical finance, a time series is a sequence of data points, measured typically at successive times spaced at uniform time intervals. Examples of time series are the daily closing value of the Dow Jones index or the annual flow volume of the...
data are scarce or not relevant (perhaps because of disturbances such as regime changes). Here, strong, reasonable, assumptions embedded in the model must replace historical evidence. Thus developing economies are often analysed using CGE models, such as those based on the IFPRI template model .
Comparative-static and dynamic CGE models
Many CGE models are comparative-staticComparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....
: they model the reactions of the economy at only one point in time. For policy analysis, results from such a model are often interpreted as showing the reaction of the economy in some future period to one or a few external shocks or policy changes. That is, the results show the difference (usually reported in percent change form) between two alternative future states (with and without the policy shock). The process of adjustment to the new equilibrium is not explicitly represented in such a model, although details of the closure (for example, whether capital stocks are allowed to adjust) lead modellers to distinguish between short-run and long-run equilibria.
By contrast, dynamic CGE models explicitly trace each variable through time—often at annual intervals. These models
are more realistic, but more challenging to construct and solve—they require for instance that future changes are predicted for all exogenous variables, not just those affected by a possible policy change. The dynamic elements may arise from partial adjustment processes or from stock/flow accumulation relations: between capital stocks and investment, and between foreign debt and trade deficits.
Recursive-dynamic CGE models are those that can be solved sequentially (one period at a time). They assume that behaviour depends only on current and past states of the economy. Alternatively, if agents' expectations depend on the future state of the economy, it becomes necessary to solve for all periods simultaneously, leading to full multi-period dynamic CGE models.
Within the latter group dynamic stochastic general equilibrium
Dynamic stochastic general equilibrium
Dynamic stochastic general equilibrium modeling is a branch of applied general equilibrium theory that is influential in contemporary macroeconomics...
models explicitly incorporate uncertainty about the future.
Solution Techniques
Early CGE models were often solved by a program custom-written forthat particular model. Models were expensive to construct, and
sometimes appeared as a 'black box' to outsiders.
Today most CGE models are formulated and solved
using one of the GEMPACK
Gempack
GEMPACK is a modeling system for CGE economic models, producedand used at the Centre of Policy Studies , Monash University, Australia, and sold by CoPS to other CGE modellers....
or GAMS
General Algebraic Modeling System
The General Algebraic Modeling System is a high-level modeling system for mathematical optimization. GAMS is designed for modeling and solving linear, nonlinear, and mixed-integer optimization problems. The system is tailored for complex, large-scale modeling applications and allows the user to...
software systems. Use of such systems has lowered the cost of entry to CGE modelling; allowed model simulations to be independently replicated; and increased the transparency of the models.
Further reading
- The Expected Benefits of Trade Liberalization for World Income and Development: Opening the "Black Box" of Global Trade Modeling by Antoine Bouët (2008)
- Adelman, Irma and Sherman Robinson (1978). Income Distribution Policy in Developing Countries: A Case Study of Korea, Stanford University Press
- Dervis, Kemal, Jaime de Melo and Sherman Robinson (1982). General Equilibrium Models for Development Policy. Cambridge University Press.
- Dixon, Peter, Brian Parmenter, John Sutton and Dave Vincent (1982). ORANI: A multisectoral model of the Australian Economy, North-Holland.
- Dixon, Peter, Brian Parmenter, Alan Powell and Peter Wilcoxen (1992). Notes and Problems in Applied General Equilibrium Economics, North Holland.
- Dixon, Peter (2006). Evidence-based Trade Policy Decision Making in Australia and the Development of Computable General Equilibrium Modelling, CoPS/IMPACT Working Paper Number G-163 http://www.monash.edu.au/policy/elecpapr/g-163.htm
- Ginsburgh, Victor and Michiel Keyzer (1997). The Structure of Applied General Equilibrium Models, MIT Press.
- Kehoe, Patrick J. and Timothy J. Kehoe (1994) "A Primer on Static Applied General Equilibrium Models," Federal Reserve Bank of Minneapolis Quarterly Review, 18(2) http://www.minneapolisfed.org/research/common/pub_detail.cfm?pb_autonum_id=258.
- Kehoe, Timothy J. and Edward C. Prescott (1995) Edited volume on "Applied General Equilibrium," Economic Theory, 6.
- Mitra-Kahn, Benjamin H., 2008, "Debunking the Myths of Computable General Equilibrium Models", SCEPA Working Paper 01-2008
- Piermartini, Roberta and Robert Teh (2005). Demystifying Modelling Methods for Trade Policy, Discussion Paper No. 10, World Trade Organization, Geneva. http://www.wto.org/english/res_e/booksp_e/discussion_papers10_e.pdf
- Shoven, John and John Whalley (1984). Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey. Journal of Economic Literature, vol.22(3) 1007-51
- Shoven, John and John Whalley (1992). Applying General Equilibrium, Cambridge University Press.
- Thorbecke, Erik and collaborators (1992). Adjustment and Equity in Indonesia, OECD Development Centre, Paris.
See also
- Dynamic stochastic general equilibriumDynamic stochastic general equilibriumDynamic stochastic general equilibrium modeling is a branch of applied general equilibrium theory that is influential in contemporary macroeconomics...
- General equilibriumGeneral equilibriumGeneral equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
- Input-output modelInput-output modelIn economics, an input-output model is a quantitative economic technique that represents the interdependencies between different branches of national economy or between branches of different, even competing economies. Wassily Leontief developed this type of analysis and took the Nobel Memorial...
- Model (macroeconomics)Model (macroeconomics)A macroeconomic model is an analytical tool designed to describe the operation of the economy of a country or a region. These models are usually designed to examine the dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of...