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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

What is a CGE Model?

Miles K. Light, Ph.D.

University of Colorado

Armenian Ministry of Economy and Trade

Yerevan, 2010

slide2

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
when is a cge model used

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
why are cge models popular

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
slide5

Basic Concepts:

Partial Equilibrium:

Economic Theory + Data

Theory Only

Theory with: numbers

slide6

Basic Concepts:

Partial Equilibrium:

Economic Theory Only:

Effect of a Tax: Theoretical

slide7

Basic Concepts:

Impact using Numbers:

Effect of a Tax: With numbers

slide8

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
slide9

General Equilibrium:

All markets interacting

  • General Equilibrium:
  • Multiple markets
  • Multiple households
  • Multiple firms
typical outputs
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 2 x 2 x 2 model
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 model13
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
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
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 x16
Example: Task: 50% Tax on X

Now Build a CGE Model to Answer the Questions.