Computable General Equilibrium Modeling and Its Application in Trade Policy Analysis Lecture 2: Basic Structure for CG

1. Computable General Equilibrium Modeling and Its Application in Trade Policy Analysis Lecture 2: Basic Structure for CGE Models Zhi Wang U.S. International Trade Commission E-Mail: zhi.wang@usitc.gov

2. Outline Multi-country model : Objective and major features Building block Structure of production, consumption and price system Model Closures Limitations and extensions Major applications

3. Objective of the Multi-Country Modeling Framework To overcome the difficulties and eliminate the errors caused from the three way translation among different model representations, and make model and modeling knowledge reusable. A domain specific, flexible modeling framework to address questions how policy changes and external shocks in one country will affect other countries in the world, especially for issues related to South-North trade such as China access to the WTO and APEC trade liberalization.

4. Building Block of Standard CGE ModelsThe role of micro economics Production, consumption and import demand are characterized by multilevel nested CES function and specified in its duality form Basic building block is pairs of composite goods (factor) prices and the corresponding component conditional demand functions. The price is also a unit cost function that is dual to an aggregator function (Diewert, 1982). It is assumed to be positive, twice differentiable, linear homogenous, and quasiconcave. In our model, it has following form:

5. Building Block of CGE Model: Unit cost and Conditional Demand functions

6. Structure of Multi-Country Models Model Dimension Regions, sectors, factors and economic agents Constraint by data and computing hardware and software Current maximum: 87 by 57 by 6, constrained by the size of GTAP database.

7. Structure of Multi-Country Models Primary Factors Arable land Unskilled-labor Skilled labor Capital Natural resources Economic Agents A household A government An investor A competitive firm in each sectorFor every region

8. Production A system of equations to calculate factor demand, production of goods and services, for domestic use or exports. Each firm produces only one product according to a CES cost function Fixed input-output coefficients for intermediate inputs. CET Function for output allocation on the domestic market or exports

9. Production Structure

10. Demand A system of equations to calculate demand for goods and services. Composite goods, made up by imports and domestic products Private household maximizes a Stone-Grey utility function Total demand: firm intermediate input, household consumption, government spending, and investment demand Sectoral domestic and import demand functions are derived by duality method according a two-level nested CES aggregation function

11. Demand Structure

12. Price System A system of equations to calculate linkages between prices at different locations and levels Eight domestic prices for good with same sector classification fob and cif prices for international prices are routine specific An exchange rate (conversion factor, not a financial exchange rate variable) in each region convert world market prices into domestic prices

13. Price System