IFPRI - ESSP2 and EDRI: Insights from Computable General Equilibrium (CGE) Analysis. Hilton, Addis Ababa, November 18, 2009

1. Simulation Models: Issues,
Design, and Implementation
Sherman Robinson
Institute of Development Studies
University of Sussex
November 2009

2. Simulation Models
• Long history in economics
– Models used in “simulation mode”
– Models designed for simulation
• Level of aggregation
– World models
– Country models
– Regional/sub-regional models
– Enterprise/farm models
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3. Commodity Market Models
• Single commodity or multimarket
– Partial equilibrium models
• Supply and demand curves
– Linear or nonlinear
– Expenditure functions may or may not be based
on demand theory
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4. Economywide Models
• “Economy” may vary in size and domain
– Macro models: macro aggregates
– General equilibrium market models
• Fixed prices: multiplier models
• Flexible prices: market interactions
• CGE models: agents interacting across markets
– Microsimulation household models
• Agents and “markets” within a household
• Agents and interactions in model economy
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5. Model Design: Simplicity
• Stylized
– “putting numbers to theory”
– Focus on particular issue
• Applied
– Larger, more detail (including institutions)
– Cover many issues
• Principle of Occam’s Razor
– Simplest model adequate to the task
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6. Model Design: Theory
• Walras, neoclassical, structuralist,
Keynes.
– Role of product and factor markets.
– Role of assets and financial markets.
• Dynamic versus static.
– Time horizon: short, medium, long.
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7. Model Design:
Notions of Equilibrium
• Flow equilibria
– Many product and factor markets
– Macro flows: G-T, S-I, M-E
– Loanable funds market
• Asset markets: equilibrium stock holding
• Intertemporal equilibrium: expectations
– Forward-looking agents
– Rational expectations
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8. Model Design: Structure
• “Deep” structural models.
– Specify agents, markets, institutions, signals,
motivation, and behavior.
• “Shallow” or “reduced form” models.
– Vague theoretical specification of relationships
among variables.
– Unidentified/unidentifiable underlying structural
model.
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9. CGE Models
• “Economywide” model with many markets:
factors and commodities
– Simultaneous equilibrium across inter-dependent
markets
• “Behavior” from general equilibrium theory
– Maximizing agents in competitive markets
• Constrained by technology and income
– Agents react to price signals
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10. Stylized CGE Model Structure
Factor Domestic Private Savings
Factor Markets Wages
Costs & Rents Gov. Savings
Taxes
Intermediate
Input Cost Households Government Sav./Inv.
Activities
Transfers
Private Government Investment
Consumption Consumption Demand
Commodity
Sales Markets
Exports Imports Foreign Transfers
Rest of the Foreign Savings
World
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11. SAM Structure
Expenditures
Receipts Domestic Rest of
Activities Commodities Factors Totals
Institutions World
Market Home con- Activity
Activities
sales sumption income
Trans- Final
Intermediate Commodity
Commodities actions market Exports
inputs demand
costs demands
Value Factor
Factors Transfers
added income
Transfers,
Domestic Tariffs, Income, Transfers, Institution
Taxes Taxes,
Institutions Taxes Taxes Savings income
Savings
Foreign
Rest of
Imports exchange
World
outflow
Foreign
Activity Commodity Factor Institution
Totals exchange
spending supply spending spending
inflow
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12. Implementation: Estimation
• Role of statistics/econometrics.
– Nature of prior information.
• Shallow reduced form models.
– Very little prior information about parameters. Not
enough theory.
– Need lots of data.
– Appropriate use of standard econometric methods
for parameter estimation.
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13. Implementation: Estimation
• Deep structural model.
– Much more prior information about parameter
values, based on theory and knowledge of model
structure.
– Usually more parameters to estimate, and data
are scarce.
– Appropriate setting for Bayesian and maximum
entropy econometric methods.
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