Abstract
Alternative to the standard linear programming model in the previous chapter, where the central planner is the maximising actor, economic models have been developed that attempt to capture the endogenous role of prices and the workings of the market system, where the essence of the general equilibrium problem is the reconciliation of maximising decisions made separately and independently by various actors. The objective of this literature is to convert the Walrasian general equilibrium structure, from an abstract representation of an ideal economy (Arrow and Debreu model 1954) into numerical estimates of actual economies.
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Notes
- 1.
- 2.
The first successful implementation of an applied general equilibrium model is due to the pathbreaking study by Johansen (1960) of the Norwegian economy. Johansen retained the fixed-coefficients assumption in modeling intermediate demand, but employed Cobb-Douglas production functions in modeling the substitution between capital and labour services and technical change.
- 3.
A presentation of the theoretical structures underlying the CGE models and their relationship to economic theory, see: Dervis et al. (1982).
- 4.
Taylor (1975).
- 5.
For a general discussion, see Shoven and Whalley (1992), pp. 37–68.
- 6.
The model is based on Dinwiddy and Teal (1988).
- 7.
Differences may exist due to transportation costs and tariff rates.
- 8.
Samuelson (1952).
- 9.
- 10.
Consequently, there can be both import and export of each category of tradable commodities in equilibrium.
- 11.
If the trade substitution elasticity equal unity, the CES utility function reduces to a Cobb-Douglas utility function.
- 12.
In the extreme case where sigma is zero, \( {M_j}/x_j^Z \) would be fixed, and imports become perfect complements of domestic products.
- 13.
Foreign currency is here regarded as an intermediate commodity (not desired in itself), where the import process requires foreign currency as input, and foreign currency is the output of the export process.
- 14.
On the other hand, if the domestic price is greater than the world market price, the commodity will not be produced.
- 15.
See Dervis et al. (1982), p. 150.
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Appendix: A Summary of Models Presented
Appendix: A Summary of Models Presented
The presentation of multisectoral general equilibrium models in this study is now complete. Here follows a summary of the most essential features:
4.1.1 The Linear Model
The central planner is assumed to be the only maximising actor.
No market (prices and quantity) interaction. In the linear programming model we interpret the shadow prices that result as a by-product of the solution as equilibrium prices.
These prices cannot be interpreted as market-clearing prices of general equilibrium theory because endogenous prices and general equilibrium interaction to simulate competitive market behaviour cannot be achieved.
Foreign trade specified as perfect substitutes to domestic production. Only inter-trade, i.e., full specialisation.
An optimum solution may only be at a vertex or an extreme point.
4.1.2 The Quadratic Model
The quadratic model is an improvement of the welfare function.
The model in Chap. 3 is formulated in terms of the maximisation of the sum of consumer’s and producer’s surplus. See also page 317–319 in Nicholson. But still the central planner is assumed to be the only maximising actor.
The existence of a two way feedback in which quantity can influence price and price can influence quantity for each sector (market interaction), is developed.
Foreign trade specified as perfect substitutes to domestic production. Only inter-trade, i.e., full specialisation (because the linear constrains are retained).
The optimum value of the objective function might occur anywhere in the feasible set, but not necessarily at a vertex or an extreme point.
4.1.3 The Computable General Equilibrium (CGE) Model
Alternative to the standard linear (and quadratic) programming model, where the central planner is the only maximising actor, the CGE model has been developed to capture the endogenous role of prices and the workings of the market system.
Decisions: The essence of the CGE model is the reconciliation of maximising decisions made separately and independently by various actors.
Prices: The model includes a general feedback mechanism that would require an adjustment in prices, i.e., the workings of market-clearing processes. Theoretically, market equilibrium prices are prices at which the demand and supply decisions of many independent economic actors maximising their profits and utilities, given initial endowments, are reconciled.
Foreign trade: With the possibility to specify foreign trade, not only as perfect substitutes as in the models above, but as a close substitute to domestic production, and a substitution that can vary according to specification, the CGE model offers a more close relation to empirical evidence. In this way the model captures the phenomena of intra-industry trade.
The reader has to note, that both a neo-classical production function of the value added component, and inter-industry flows (the input–output flows) in the commodity balance equations can be incorporated in the CGE model.
4.1.4 Real World Applications: The GAMS Program
If you are interested in the practical application of real word problems the GAMS computer program is recommended. GAMS homepage is www.gams.com. Here you will find the GAMS program library. Here you will also find reference to literature, tutorials, and course outlines on GAMS.
A short, and here recommended, description on programming in GAMS is A GAMS Tutorial. The handbook A Standard Computable General Equilibrium (CGE) Model in GAMS can be used as a reference book for further studies. Note, that some references are rather extensive in the number of pages. Hence, study the reference first on screen, and then print out only the selected parts you need.
The GAMS program itself (student version) can be installed on your computer. It is possible to download the program (student version) on your own private computer from the GAMS homepage. If you choose to download the GAMS program from the GAMS homepage, read the instructions carefully.
MPSGE is a mathematical programming system for general equilibrium analysis which operates as a subsystem within GAMS. MPSGE simplifies the modelling process and makes AGE modelling accessible to any economist who is interested in the application of these models. http://www.gamsworld.org/mpsge/index.htm.
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Norén, R. (2013). A Market with Autonomous Economic Decision Makers: Features of the CGE Model. In: Equilibrium Models in an Applied Framework. Lecture Notes in Economics and Mathematical Systems, vol 667. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-34994-2_4
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