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Introduction to Policy Simulations with ISIM-MAMS

A Simple SAM-based CGE Model

Martín Cicowiez Hans Lofgren

(CEDLAS-UNLP) (World Bank)

Presentation for the course "Introduction to Policy

Simulations with ISIM-MAMS“, World Bank, Washington,
D.C., December 9-13, 2013

Outline
• CGE models: A Quick Overview
• Key features of SAMs
• A simple SAM-based CGE model

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CGE Models: A Quick Overview

• CGE = Computable General Equilibrium
– definition: an open-economy, economy-wide model
with flexible prices, multiple sectors and households,
and an important role for government policy
• History of CGE modeling
– 1st model developed by Johansen in the late 1950s
– since mid-1970s, methods have been further
developed and applied to most countries, both
developed and developing
– specially attractive for developing countries where
data is relatively scarce

CGE Models: A Quick Overview – cont.

• Computable = solvable numerically
• General = economy-wide
• Equilibrium =
– optimizing agents have found their best solutions
subject to their budget constraints
– quantities demanded = quantities supplied in
factor and commodity markets
– agents and nation live under budget constraints
• “Real” model: only relative prices matter; no
modeling of inflation or the monetary sector.

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CGE Models: A Quick Overview – cont.

• CGE models are useful when indirect effects
are important and prices matter.
• Example 1: increase in worker migration and
remittances
– Direct effect: increased incomes for recipient
households
– Key indirect effects
• increased demand from recipient households
• exchange rate appreciation
• wage pressures in labor market

CGE Models: A Quick Overview – cont.

• Example 2: tariff cuts
– Direct effect: decline in domestic prices for
commodities with tariff cut
– Key indirect effects
• production and consumption responses to price decline
• government responses (decreases in spending?; tax
increases?; increased borrowing?)
• real exchange rate depreciation
• In general, indirect effects matter when
changes (in policy or exogenous) are
important.

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Flow Payments in CGE 1

domestic wages and rents
Factor
Households
Markets

private consumption
Factor demand

Activities

Commodity
dom demand
Markets

Dimensions of the Example

• 2 Activities
• 2 Commodities
• 2 Factors
• 2 Households

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Features of a SAM
• Explicitly or implicitly, a SAM is the key source
of data for most CGE models.
• A comprehensive, economywide data
framework.
• Social => often focus on incomes and spending
of households of different types.
• Disaggregation and classification of accounts
vary widely across different SAMs.

Features of a SAM – cont.

• Used for descriptive purposes and as data
input for economic models (which provide
explanations for SAM payments).
• A square matrix with identical row and column
accounts.
• Each cell shows payment from its column
account to its row account
• Column totals = row totals

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Accounts in Example SAM

Account Definition
a-agr agricultural activity
a-nagr non-agricultural activity
c-agr agricultural commodity
c-nagr non-agricultural commodity
f-lab labor factor
f-cap capital factor
h-urb urban household
h-rur rural household

Example SAM
a-agr a-nagr c-agr c-nagr f-lab f-cap h-urb h-rur total
a-agr 125 125
a-nagr 150 150
c-agr 50 75 125
c-nagr 100 50 150
f-lab 62 55 117
f-cap 63 95 158
h-urb 60 90 150
h-rur 57 68 125
total 125 150 125 150 117 158 150 125

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Example SAM and Model

• Key simplifications compared to real-world
economy:
– no government or taxes
– no rest of world
– no intermediate inputs
– no separation of savings and investment from
other payments

Notation
• Endogenous variables = upper-case Latin
letters.
• Exogenous variables = upper-case Latin letters
with a bar.
• Parameters = lower-case Latin letters or lower
case Greek letters.
• Set indices = lower-case Latin letters as
subscripts to variables and parameters.

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Sets

Index Definition
c commodities
a activities
f factors
h households

Variables
Name Definition
CPI consumer price index
P(c) price of commodity c
PA(a) output price per unit of activity a
Q(c) output level for commodity c
QA(a) level of activity a
QF(f,a) quantity demanded of factor f from activity a
QH(c,h) quantity consumed of commodity c by household h
WF(f) wage (rent) of factor f
YF(f) factor income
YH(h) income of household h

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Behavioral Equations: Firms

The cost minimization problem for a firm that produces
with a Cobb-Douglas production function can be written
as (for simplicity, the activity index is omitted)

min WFf QFf

f

f
s.t. QA    QFf
f

The firm chooses how much labor and capital to demand

taking as given the factor wages, the level of production,
and the production technology.

Behavioral Equations: Firms – cont.

The problem of the firm can be rewritten as
  
min Z   WF f QF f    QA    QF f f 

f  f 

where λ is the Lagrangian multiplier. The First Order

Conditions (FOCs) are

Z 
 WF f   f , aQF f1  QFf ' f '  0
QF f f'

Z 
 QA    QFf f  0
 f

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Behavioral Equations: Firms – cont.

Manipulating the first FOC,
 f ,a QA
WF f 
QF f

Then, factor demands can be written as

PA f QA
QF f 
WF f

where, assuming perfect competition, the Lagrange

multiplier λ (marginal cost) was replaced by the product
price PA.

Behavioral Equations: Households

The utility maximization problem for a consumer with a
Cobb-Douglas utility function can be written as (for
simplicity, the household index is omitted)

max U   QH cc
c

s.t. YH   Pc QH c
c

The consumer’s problem is to choose the affordable

bundle of goods that maximizes her utility, taking as given
the prices of the goods, her income, and the utility
function.

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Behavioral Equations: Households – cont.

In the 2 goods case, the problem of the consumer can be
rewritten as
max Z  QH 11 QH 2 2   YH  P1QH1  P2QH 2 

FOCs
Z QH 1   1QH 11 1QH 2 2  P1  0

Z QH 2  QH11 2QH 2 2 1  P2  0

Z   YH  P1QH 1  P2QH 2  0

Behavioral Equations: Households – cont.

From the first two FOCs,
1QH1 1QH 2
1
P2

  1
 1
QH1  2QH 2
1 2
P2

1QH 2 P1

 2QJ1 P2

2
P2QH 2  PQH
1 1
1

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Behavioral Equations: Households – cont.

Using the above equation to substitute for P2QH 2 in the
budget constraint,

2
YH  P1QH1  P QH
1 1 1

  
YH  P1QH1 1  2 
 1 

  2 
YH  P1QH1  1 
 1 

Behavioral Equations: Households – cont.

Using the same substitution procedure to derive the demand
function for commodity 2, the two demand functions become
1YH
QH1 
P1

 2YH
QH 2 
P2

where the key assumption is α1 + α2 = 1.

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Features of Simple CGE Model

• Disaggregation determined by database.
• Cobb-Douglas functions for production and
household consumption.
• Prices, including wages and rents, clear
markets for sector outputs and factors.
• The model is written so that the same algebra
applies irrespective of disaggregation of c, a,
h, and f.

Equations

QAa  a  QFf , fa,a
f

QF f ,aWF f   f ,a PAa QAa

Qc   a ,cQAa
a

PAa   a ,c Pc
c

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Equations – cont.
YF f   WF f QF f , a
a

YH h   shry h , f YFf
f

PcQH c, h   c, hYH h

qfs f   QF f , a
a

Equations -- cont.
 QH
h
c, h  Qc

 P cwts
c
c c  CPI

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Variable and Equation Count

• Number of variables
2 a + 2 c + 2 f + h + (f ∙ a) + (c ∙ h) + 1
• Number of equations
2 a + 2 c + 2 f + h + (f ∙ a) + (c ∙ h) + 1

Numéraire
• Like most CGE models, this one only
determines relative prices. Given this, a
numéraire has to be imposed, in this case we
chose the CPI.
• By virtue of Walras’ Law, one equation is not
independent of the others and may be
omitted from the model. In this case, we omit
one of the two commodity market equilibrium
conditions.

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Calibration
• The model is calibrated on the basis of a data
set for a base period (here only a SAM)  the
values for the parameters and the exogenous
variables of the model – φ, α, δ, shry, θ, and
qfs – are defined (estimated) in a manner that
enables the model solution to precisely
replicate the base-year data set.

Steps in Model Calibration

1. Prices and wages (P and W; implicitly PA and CPI) are set at one.
(Implication: the related commodity and factor quantities reflect
what is traded at a price or wage of one.)
2. Given (1) and selected values of SAM cells, it is possible to define
the base-year levels of all remaining variables (quantities: QA, Q,
QF, QH; incomes: YF and YH) and the factor supply parameter (qfs)
3. The share parameters (α, δ, shry) are defined as shares of cell
payments in column totals (for sectors, factors, and households)
4. φ is defined once the other items in Equation 1 are defined
5. When solved, the resulting model will replicate base-year data;
the model solution can be used to define a SAM (which will be
identical to he original SAM)

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Calibration: Production Side

From the first FOC,
WFf QFf SAM lab, agr 62
 f ,a   lab, agr    0.496
PAaQAa SAM tot , agr 125

From the second FOC,

QAa
a  
 QF f ,fa,a
a

Calibration: Consumption Side

From the demand functions,
Pc QH c ,h
 c, h 
YH h

SAM agr ,urb 50

 agr ,urb    0.333
SAM urb ,tot 150

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Exercises
• (1) Double the numeraire
• (2) Double the labor supply
• (3) Double the capital stock
• In all cases, analyze the results
– compute welfare changes

Results
base change%
QA (Nom) Num-2 LabSup-2 CapSup-2
a-agr 125.0 0.0 41.0 41.8
a-nagr 150.0 0.0 28.9 55.1

base change%
QF (Nom) Num-2 LabSup-2 CapSup-2
f-lab a-agr 62.0 0.0 100.0 0.0
f-lab a-nagr 55.0 0.0 100.0 0.0
f-cap a-agr 63.0 0.0 0.0 100.0
f-cap a-nagr 95.0 0.0 0.0 100.0

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Results – cont.
P base Num-2 LabSup-2 CapSup-2
c-agr 1.000 2.000 0.951 1.049
c-nagr 1.000 2.000 1.041 0.959

WF base Num-2 LabSup-2 CapSup-2

f-lab 1.000 2.000 0.671 1.488
f-cap 1.000 2.000 1.342 0.744

base change%
QH (Nom) Num-2 LabSup-2 CapSup-2
c-agr h-urb 50.0 0.0 41.0 41.8
c-agr h-rur 75.0 0.0 41.0 41.8
c-nagr h-urb 100.0 0.0 28.9 55.1
c-nagr h-rur 50.0 0.0 28.9 55.1

References
• Lofgren, H. (2003). Exercises in General
Equilibrium Modeling Using GAMS and Key to
Exercises in CGE Modeling Using GAMS.
Microcomputers in Policy Research 4. IFPRI.
• Lofgren, H., R. Lee Harris and S. Robinson
(2002). A Standard Computable General
Equilibrium (CGE) Model in GAMS.
Microcomputers in Policy Research 5. IFPRI.

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