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What is a CGE Model?. Miles K. Light, Ph.D. University of Colorado Armenian Ministry of Economy and Trade Yerevan, 2010. Basic Concepts:. What is a CGE Model?. A “Computable General Equilibrium” (CGE) model: is an economic model that combines the following:
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What is a CGE Model? Miles K. Light, Ph.D. University of Colorado Armenian Ministry of Economy and Trade Yerevan, 2010
Basic Concepts: What is a CGE Model? • A “Computable General Equilibrium” (CGE) model: • is an economic model that combines the following: • firms (factories,companies) that attempt to maximize profits and minimize costs • households who maximize “welfare” (consumption) by choosing consumption goods according to price • markets: where prices adjust until supply and demand is equal
Basic Concepts: When is a CGE model used? • Some Previous Uses: • 1997: Determine how Carbon-Limits would impact OECD countries under the Kyoto Protocol • 2002: Examine the economic effect of Free Trade with USA would impact the economy in Peru, Colombia, and Ecuador. • 2003: Assess how migration would impact the EU’s economy with European enlargement • 2004/2005: Consider the “total” economic impact of various tax-reform packages in Jamaica and Mongolia
Basic Concepts: Why are CGE Models Popular? • Main Strengths: • Combination of standard theory with detailed data • Optimization and “Micro-foundations”: An improvement from Keynesian macroeconomic models • Households respond to price changes • Firms change output and inputs when markets shift • Provides “evidence” to support claims: • Benefits and costs can be calculated, and used as evidence to support particular policies • Trade-offs between policies can be quantified
Basic Concepts: Partial Equilibrium: Economic Theory + Data Theory Only Theory with: numbers
Basic Concepts: Partial Equilibrium: Economic Theory Only: Effect of a Tax: Theoretical
Basic Concepts: Impact using Numbers: Effect of a Tax: With numbers
Basic Concepts: Using the previous Partial Equilibrium model, we can say: • Effect of a 100% tax: • Output Declines: • $2,000 to $1,000 (50% decline) • Consumer prices rise: • $20/each to $30/each (50% increase) • Tax Revenues = $500
General Equilibrium: All markets interacting • General Equilibrium: • Multiple markets • Multiple households • Multiple firms
Typical Outputs • General Outputs: • Production Levels • New Price Levels & Inflation • International Trade Volume (imports and exports) • Welfare (Equivalent Variation) • Factor Returns (Wages, Return to Capital) • Specialized Outputs: (if integrated) • Productivity and Competition (for Increasing Returns to Scale Technology) • Environmental Indicators (CO2, Pollutants) for energy-economy models
Example: Simple 2 x 2 x 2 Model- 2 Sectors- 2 Factors - 2 Goods
Example: 2 x 2 x 2 Model • An example Economy: • 2 Production Sectors: • X Sector (e.g., farming); and • Y Sector (e.g., industry) • Each sector produces an output good: • “PX” is produced by the X Sector • “PY” is the output of the Y Sector • There are 2 “factors” of production: • Labor, which commands a price “PL” • Capital, which commands a price “PK” • One “Household” – Represents the average family or “national family”. The household owns the factors of production, and purchases the goods.
Example: 2 x 2 x 2 Model • Historical Data: Production and Consumption in 2007 for the Example Economy • Output: • X Sector Output = 100 million USD ( 100 units at a price of 1.0 ) • Y Sector Output = 100 million USD ( 100 units at a price of 1.0 ) • Production Structure • X Sector Purchased: • 40 million USD in Labor (wages) / 60 million in capital expenses (rent/machines) • Y Sector Purchased: • 60 million USD in Labor (wages) / 40 million in capital expenses (rent/machines) • Total purchases of labor and capital: 200 million USD. • Consumption: The household purchased • 100 million USD of good “PX” • 100 million USD of good “PY”
Example: 2007 Data The Social Accounting Matrix Production Sectors Consumers Markets | X Y W | CONS ------------------------------------------------------ PX | 100 -100 | PY | 100 -100 | PW | 200 | -200 PL | -40 -60 | 100 PK | -60 -40 | 100 ------------------------------------------------------
Example: Task: 50% Tax on X • Assignment: The government is considering a 50% tax on the production of the X Sector. They want to know the following: • Tax Revenue Collections • Change in Production for all Sectors • Change in Employment & Return to Capital • Overall impact upon consumption and prices (CPI)
Example: Task: 50% Tax on X Now Build a CGE Model to Answer the Questions.
