An Applied Model: The CGE Mini Model
In this chapter a CGE model (the CGE mini model) is presented. The model is simple enough to be presented in a few pages and yet complicated enough to demonstrate the application of the general CGE structure. In short, the focus of this chapter is to prov
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An Applied Model: The CGE Mini Model
In this chapter a CGE model (the CGE mini model1) is presented. The model is simple enough to be presented in a few pages and yet complicated enough to demonstrate the application of the general CGE structure. In short, the focus of this chapter is to provide examples of structural adjustment in an open economy. The numerical applications of this chapter will be an examination of the sensitivity of the model to systematic variation in key variables of the adjustment process. Here we emphasise the effect of changes (government intervention) in the fixed rate of real exchange and growth in the capital stock.
5.1
The Basic Structure of the CGE Model
The behaviour of economic agents in this model is designed according to neoclassical microeconomic theory with relative prices playing a major role in the determination of economic activities. Producers minimise costs subject to a given production technology, and consumers maximise utility given their total expenditure determined as a constant fraction of their income. Firms (within sectors) are assumed to maximise profits, and labour demand functions come from the first order conditions equating the wage with the marginal revenue product of labour of each category. The model assumes perfect competition in all markets and domestic and foreign commodities are treated as imperfect substitutes according to 1 The CGE mini-model is included in the GAMS model library which is distributed with the GAMS system. The CGE mini-model is a minor version of an equilibrium model that originally comes from Chenery, Lewis, de Melo, and Robinson in their work in designing an equilibrium development model for Korea. The model is originally designed for the study of three development strategies. The first option was the strategy of export expansion, the second option was the strategy of import substitution, and the third option was a strategy between the two extreme cases. This model illustrates the basic use of CGE models. See further: Chenery et al. (1986), pp. 311–347.
R. Nore´n, Equilibrium Models in an Applied Framework, Lecture Notes in Economics and Mathematical Systems 667, DOI 10.1007/978-3-642-34994-2_5, # Springer-Verlag Berlin Heidelberg 2013
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5 An Applied Model: The CGE Mini Model
Armington’s (1969) specification. Exports are determined by an exogenous foreign demand and the relative export price is measured in foreign currency.2 Prices in the foreign markets are linked but need not be identical to the domestic market. However, the world price in foreign currency (dollars) is assumed to be exogenous, i.e., the small country assumption.3 Thus, the CGE model simulates the working of a market economy. In each period, it solves for wages and prices that clear the markets for labour and commodities. The model is Walrasian in that only relative prices matter. The numeraire against which all relative prices are measured is defined as an index of domestic prices. The model satisfies Walras’s law, which implies that there cannot be a sit
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