NAF

International Working Paper Series

Year 2013 paper n. 13/01

Technical Issues for Modelling

Economic Partial Equilibrium Problems with GAMS

Maria Sassi
Department of Economics and Management
University of Pavia – Italy
e-mail : msassi@eco.unipv.it

The online version of this article can be found at:

http://economia.unipv.it/naf/

0
Scientific Board

Maria Sassi (Editor) - University of Pavia

Johann Kirsten (Co-editor)- University of Pretoria
Gero Carletto - The World Bank
Piero Conforti - Food and Agriculture Organization of the United Nations
Marco Cavalcante - United Nations World Food Programme
Luc de Haese - Gent University
Stefano Farolfi - Cirad - Joint Research Unit G-Eau University of Pretoria
Ilaria Firmian -IFAD
Mohamed Babekir Elgali – University of Gezira
Firmino G. Mucavele - Universidade Eduardo Mondlane
Michele Nardella - International Cocoa Organization
Nick Vink - University of Stellenbosch
Alessandro Zanotta - Delegation of the European Commission to Zambia

Copyright @ Sassi Maria ed.

Pavia -IT

naf@eco.unipv.it

ISBN: 978-88-961889-11-5

1
 3
GAMS modeling structure: the input file

3.1. Introduction
This Chapter considers the input file, that is one of the core component of the GAMS modeling
framework. Basic commands and their specification are illustrated following the structure of an
equilibrium market model for a closed economy. Additional information on GAMS language are
introduced in the following developing specific models.
For further details it is recommended to consider the GAMS’ user guide included in the Help of the
software.

3.2. Basic input elements

Figure 16 provides an example of model written in GAMS language. It is the representation of the
equilibrium market model for two commodities developed in Par. 1.4.
This example is adopted to provide an overview of a model structure in GAMS.
In blue, in bold and capitals, the basic commands are indicated. As illustrated in Table 2, each of them
must be introduced in a specific way. More precisely, Sets, Parameters, Variables and Equations must
be first declared and then defined.
With the Declaration the user must specify the name of the element and provide a description; this
latter is written in blue by the software. With the Definition, a process that in process in GAMS is
called initialisation, the user must assign a member (of a set) or value (of the parameters) to the
elements or specify the type of element. Members are written in green while numbers in black.
Colours are important in GAMS. If a declaration or definition is written a colour different from the
above mentioned, the user has made a syntax error.

2
Figure 16 – Equilibrium market model for two commodities in GAMS

3
 Table 2 – GAMS’ commands
Inputs
Sets
Declaration
Definition: Assignment of members
Data (Parameters, Tables, Scalars)
Declaration
Definition: Assignment of values
Variables
Declaration
Definition: Assignment of type (optional)
Optional: assignments of bounds and/or
initial values
Equations
Declaration
Definition
Model statement
Solve statement
Optional: Display statement

3.3. Syntax: general rules

Before introducing the syntax for each input command, six general remarks should be introduced. They
are:
a. First declare and second use - A GAMS model is a collection of statements in the GAMS language
whose order is governed by the only rule according to which an entity of the model cannot be
referenced before it is declared to exist;
b. Style does not matter - GAMS statements may be laid out typographically in almost any style that is
appealing to the user and multiple lines per statement, embedded blank lines, and multiple statements
per line are allowed;
c. Semicolon terminates a statement – if the semicolon is not properly used GAMS does not recognises
the following command, indicates a mistake and the model cannot be solved. Table 3 illustrates the use
of semicolon.

4
 Table 3 – Use of semicolon
USE SEMICOLON DO NOT USE SEMICOLON
- after the end of each declaration block - after each line within a block (for blocks of
(parameters, variables, equations, etc.) parameters, variables, etc.)
- after each defined parameter - after each declared scalar and parameter, only at the
end of the block
- after each defined table - after each declared variable
- after each defined equation - after each declared equation

d. upper- and lower-case letters have the same meaning - GAMS compiler does not distinguish between
that, so the user is free to use either:
e. Comments and documentary text can be included in the model - They are useful to explain parts of
the model and can be inserted in two ways. Any line that starts with an asterisk (*) is disregarded as a
comment line by the GAMS compiler. In Figure 16, this statement has been adopted to specify the type
of model developed before model design (* GAMS model market equilibrium in a closed economy).
Characters are in grey. A second way to include comments and documentary text is with the specific
GAMS statements $ontext and $offtext. $ontext opens comments or documentary text and $offtext close
it. In the example in Figure 16, the asterisk should have been replaced by the following syntax: $ontext
GAMS model market equilibrium in a closed economy $offtext,that is

$ontext GAMS model market equilibrium in a closed economy $offtext

f. Start entities with a letter and stop at nine alpha-numerical characters - The names given to the
entities of the model must start with a letter and can be followed by up to nine more letters or digits.

3.4. Model structure and command syntax

Modelling in GAMS starts with writing in pencil the model. The model structure and command syntax
is illustrated taking as reference the market equilibrium model introduced in par. 1.3 and 1.4 and
recalled in Figure 17.
In GAMS the elements of the model are defined and declared with specific commands, shown for our
model in Table 4.

5
 Figure 17 – Linear equilibrium market model for meat and fish
- Two commodities
𝑖𝑖 = 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚, 𝑓𝑓𝑓𝑓𝑓𝑓ℎ
- The system of equations
𝐷𝐷𝑖𝑖 = 𝑎𝑎𝑖𝑖 + 𝑏𝑏𝑖𝑖 ∗ 𝑃𝑃𝑖𝑖
𝑆𝑆𝑖𝑖 = 𝑓𝑓𝑖𝑖 + 𝑧𝑧𝑖𝑖 ∗ 𝑃𝑃𝑖𝑖
𝐷𝐷𝑖𝑖 = 𝑆𝑆𝑖𝑖
- The value of the observed variables
𝑎𝑎(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = 1.07 𝑎𝑎(𝑓𝑓𝑓𝑓𝑓𝑓ℎ) = 1.012
𝑏𝑏(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = −0.804 𝑏𝑏(𝑓𝑓𝑓𝑓𝑓𝑓ℎ) = −3.09
𝑓𝑓(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = 1.03 𝑓𝑓(𝑓𝑓𝑓𝑓𝑓𝑓ℎ) = 0.47
𝑧𝑧(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = 1.08 𝑧𝑧(𝑓𝑓𝑓𝑓𝑓𝑓ℎ) = 4.87

- The endogenous variables

𝐷𝐷𝑖𝑖 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑
𝑆𝑆𝑖𝑖 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠
𝑃𝑃𝑖𝑖 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝

6
 Table 4 – Elements of a model and GAMS’ command for their specification
Element Type GAMS’ Command
i Index Sets
Observed values
ai Observed exogenous variable Parameters
bi Observed parameter Parameters
fi Observed exogenous variable Parameters
zi Observed parameter Parameter
Unknown variables
Di Endogenous variable Variables
Si Endogenous variable Variables
Pi Endogenous variable Variables
System of equations
Demand Demand function Equations
Supply Supply function Equations
Equil Equilibrium condition Equations

3.4.1. Sets
The command Sets defines the indices used in the model, which must be first declared and then defined
(Figure 18).

Figure 18 – Declaration and definition of Sets

Declaration implies to list the names of the sets (i in our case) with a short description (in our case
Commodity type) while definition consists in listing the members of each set (in our case Meat and
Fish).
Figure 19 shows the syntax for this command where the words in between < > describe what type of
words should go in that place. < > are not GAMS syntax

7
 Figure 19 – Syntax for the command Set

Definition of the set members must be put in slashes with set members one below the other or in the
same row, but in this case each set is separated by a comma.
A semicolon must be written at the end of the definition of Sets to conclude the command specification.
The choice of the name of the set members does not affect the overall result: the two members meat
and fish might be called 1 and 2, or Mary and Susy and still they would be equally working. Name are
not part of GAMS syntax.
The command Sets is only necessary when one or more elements in the model are indexed, if not the
command must be excluded. Sets is the only compulsory when there are indices.

3.4.2. Parameters
The command Parameters specifies the observed exogenous variables and coefficients of the model. It
is articulated in a section where these elements are declared and another where they are defined (Figure
20).

Figure 20 – Parameters declaration and definition

8
With the declaration the names of the parameters with a short description is provided while definition
consists in the assignment of a value or a formula to each parameter. As illustrated in Figure 20 indices
must be put in quotation marks.
A semicolon is located at the end of the Parameters declaration and after each defined parameter.
Figure 21 shows the syntax for this command.

Figure 21 – Syntax for the command Parameters

Two alternative ways for the specification of the command is illustrated in Figure 22.

Figure 22 - Alternative syntax for the command Parameters

GAMS also accepts to break this one statement into four, putting a semicolon at the end of each of
them, as illustrated for the first alternative by Figure 23.
The use of tables and direct assignment for data entry will be illustrated in the following, when
requested by the examples.

9
 Figure 23 – Alternative use of semicolon
in Parameters entry

3.4.3. Variables
The command Variables defines the endogenous variables used in the model. They must be declared
and optionally defined.
Declaration consists in listing the variables with a short description of each of them and end with a
semicolon, as illustrated by Figure 24 for our example.

Figure 24 – Declaration of the command Variables

The syntax for this command is presented in Figure 25.

Figure 25 - Syntax for the command Variables

Definition is an optional component that usually refers to the specification of the variable type, as
reported in Table 5.
By default all variables are free. However, if the user wants to specify the variable type, the command
corresponding to the chosen variable type must be added.

10
 Table 5 – Variable type
Variable type Allowed range of variable
Free -∞ to +∞
Positive 0 to +∞
Negative -∞ to 0
Binary 0 or 1
Integer 0, 1, …, 100

For example, if in our example the user wants the prices-an endogenous variable-to be positive, the
definition for Variables must be written as in Figure 26.

Figure 26 – Specification of the variable type

The user has the possibility to apply special records in order to assign a bound or an initial value to a
variable. This can be done with the peculiar variable suffixes shown in Table 6.

Table 6 – Main suffixes

Suffix Description
.L Level or boundary (edge) value
.LO Lower boundary
.UP Upper boundary
.FX Fixed value

For example, if the user wants equilibrium prices to be positive the command to be included is
P.LO(i) = 1

3.4.4. Equations
The command Equation specifies the equations that characterize the relationships between the variables
and parameters in the model. They must be declared and defined, as in Figure 27 for our example.
Equation declaration lists the names of the equations with a brief description of each one and end with
a semicolon. Equation definition specifies the equations themselves.
11
 Figure 27 – Declaration and definition of Equations

The two points (..) after the equation name are compulsory. In equations =E= represent the equal sign.
A semicolon must be used after each defined equation.
The syntax is illustrated in Figure 28.

Figure 28 – Syntax for the command Equation

Table 7 provides a selection of GAMS notations for standard arithmetic operations, indexed operations
and functions.

Table 7 – Notations for a selection of operations

Operation Symbol Operation Symbol
Standard arithmetic operations Indexed operations
Multiplication * Summation SUM(set domain, element)
Subtraction - Product PROD(set domain, element)
Addition + Functions
Division / Exponential EXP(.)
Exponent ** Logarithm LOG(.)
Equality in operation = Maximum MAX(.,.)
Minimum MIN(.,.)

12
3.4.5. Model and Solve
The command Model names the model and, in brackets, lists the equations that are part of it followed
by the semicolon (Figure 29).

Figure 29 – The command Model

The name given to the model (in our case CLMKEQ) does not affect the overall result. It is not GAMS
language and can be selected as the user likes.
The list of each single equation that become part of the model can be substituted by the statement All as
follows:

MODEL CLMKEQ /ALL/ ;

ALL tells GAMS to include all equations in the model.

The syntax for this command is illustrated in Figure 30.

Figure 30 – Syntax for the command Model

As in the case of the command Sets, also with this command the equation names can be put on the
same line, but they must be separated by a comma.

13
The command Solve tells GAMS the method to use in order to “solve” the model, that is to find the
values of the endogenous variables that make all equations true. The defined command in our example
and the syntax are shown in Figure 31.

Figure 31 - The command Solve

With this command the user selects the method adopted to solve the model. In our example the Mixed
Complementarity Problems (MCP) which can be used both for linear and nonlinear programming.
The list of available solution procedures see the GAMS’ user guide.
The solve statement completes the modeling structure.

3.5. Checking errors in the code string or file and running the model
Before running the model, a check for compilation errors, such as typing mistakes, is advisable.
Two commands can be alternatively used for compiling mistakes. The user can:
- Click on File in the Menu headings and then on Compile; or
- press Shift+F9.
When the GAMS compiler encounters an error in the input file, it inserts a coded error message inside
the echo print, a new window, on the line immediately following the scene of the offense.
These messages always start with **** and contain a $ directly below the point at which the compiler
thinks the error occurred. The $ is followed by a numerical error code, which is explained after the
echo print.
Making reference to our example, let us assume that, by mistake, an error in the definition of one
parameters has been done: the intercept of the fish demand function has been written as fis instead of
fish (Figure 32).

14
 Figure 32 - Typing mistake in Parameters definition in the input file

Checking error, the echo print will highlight the mistake as shown in Figure 33, and at the end the
typology of error will be clarified. In our case there is a violation of the domain of the specific element.

Figure 33 - Echo print with error indication

Once all the errors have been corrected, the model can be run following three possible ways:
- Clicking on the red arrow on the Buttons line;
- Pressing F9; or
- Clicking on File in the Menu headings and then on Run.
Two new windows will provide the output of the model.

15
 4
GAMS modeling structure: the output files

4.1. Introduction
Once a model is run with GAMS, two windows appear (Figure 34).

Figure 34 – Output files

The one provides information about the solution procedures, such as the time spent to find the solution,
the other show the solution: it is the window where the output can be red.
The solution window is structured into the six sections. They are, in the order in which they are
presented in the output file:
- Echo Print;
- Reference Maps;
- Equation Listings;

16
- Model Statistics;
- Status Reports;
- Results.
The Echo Print, Reference Maps and Model Statistics give information on the model and its
components while the other sections are the result of the Solve command.
The aim of this Chapter is to illustrate each of these components.

4.2. Echo Print and Reference Maps

Echo Print is the first section of the output from a GAMS run. It is a copy of the input file. As
previously underlined possible spelling, typing, conceptual or mathematical errors are indicated in this
section in the form analysed in the previous chapter at Par. 3.5. For the sake of future reference, GAMS
puts line numbers on the left-hand side of the echo, as shown for our example by Figure 35.

Figure 35 – The initial part of the Echo Print

Reference Maps contain summaries and analyses of the input file for the purposes of debugging and
documentation. They are a Cross-reference map and a Model entities map. The IDE version of GAMS
does not show these maps by default. They must be included with particular statements:
- $ONSYMXREF for the Cross-reference map;
- $ONSYMLIST for the Model entities map;
written at the beginning of the input file (Figure 36).
They are not compulsory; the user can decide to include none, one or both the maps.

17
 Figure 36 – Statements for Reference Maps
to be included at the beginning of the input file

The Cross-reference map is an alphabetical, cross-referenced list of all the entities (sets, parameters,
variables, and equations) of the model. Figure 37 shows a part this map related to our example.

Figure 37 – Cross-reference map

18
For each element of the model it provides three types of information, the symbol, the type and
references.
Let us consider the first element of the map. It is the intercept of the demand function. The cross-
reference map informs that that this coefficient is represented in the model by the symbol “a”, is
specified as a parameter that was declared in line 11, defined (assigned two values) in line 15, and
referenced in line 28. The number of the lines are those in the Echo Print, as illustrated in Figure 38
with reference to our example.

Figure 38 – Echo Print and cross-reference map information

The Model entities map provides a list of model entities grouped by type and listed with their
associated description, as in Figure 39 for our example.
The user can compare this map with the previously written Table 4 in Par 3.4 in order to verify if all the
elements have been included in the model.

19
 Figure 39 - Model entities map

4.3. Equation Listings

The equation listing is probably the best device for studying an extremely important question, that is if
GAMS has generated the intended model.
It shows the specific instance of the model that is created when the current values of the sets and
parameters are plugged into the general algebraic form of the model.
In the model of our example there is a generic demand equation in the input file. It is

DEMAND(i)..
D(i) =E= a(i) + b(i)*P(i);

The model has also specified the parameters

20
 PARAMETERS
a('Meat')=1.07; a('Fish')=1.012;
b('Meat')=-0.804; b('Fish')= -3.09;

The equation listing of the corresponding specific demand equations is:

---- DEMAND =E= Demand equation

DEMAND(Meat).. D(Meat) + 0.804*P(Meat) =E= 1.07
DEMAND(Fish).. D(Fish) + 3.09*P(Fish) =E= 1.012

The constant parameter (i.e. the demand coefficient) is on the right-hand side.
By default the equation listing contains a maximum of three specific equations for each generic
equation (in our example, the generic equation in ---- DEMAND =E= Demand equation and the
specific equations are two). In order to change this number a command must be inserted in the input
file prior to the solve statement. It is
option limrow = r ;
with r the number of desired equations.
The default output also contains a section called the Column Listing, analogous to the equation listing,
which shows the coefficients of three specific variables for each generic variable. To change the default
number of specific column printouts per generic variable, the above command can be extended:
option limrow = r, limcol = c ;
where c is the desired number of columns.
Setting limrow and limcol to 0 is a good way to save paper after the model has been debugged.

4.4. Model Statistics

Model Statistics provides a group of statistics about the model size, as illustrated in Figure 40 for our
example.
The Block counts inform on the number of generic equations and variables. For the model to be
balanced they must be equal. In our example there are three general equations, Demand, Supply and
Equilibrium, and three generic variables Demand, Supply and Price.

21
 Figure 40 – Model Statistics

The Single counts refer to individual rows and columns in the specific model instance being generated.
In our example, there are six specific equations (Meat Demand, Meat Supply, Meat Equilibrium, Fish
Demand, Fish Supply and Fish Equilibrium) and six specific variables (Meat Demand, Meat Supply,
Meat Price, Fish Demand, Fish Supply and Fish Price).
The Non zero elements entry refers to the number of non-zero coefficients.
For nonlinear models, some other statistics are given to describe the degree of non-linearity in the
problem:
- The non linear n-z entry refers to the number of nonlinear matrix entries in the model.
- The derivative pool and constant pool provide more information about the nonlinear information
passed to the nonlinear solver.
- The code length entry reports on the complexity of the nonlinear part of the model. The numerical
value reports the amount of code GAMS passes to the nonlinear solver that describes all the nonlinear
terms in the model
Generation time if the time used since the syntax check finished, while execution time is the requested
time for running the model.

4.5. Status Report

The Status Report shows a brief solve summary, as illustrated in Figure 41 for our example.
The two most important entries are Solver Status and the Model Status. They are preceded by the same
**** string as an error message. The desired solver status is 1 NORMAL COMPLETION, but there are
other possibilities illustrated in Table 8.

22

Table 8 – Alternative solver status
Solver status
1 NORMAL COMPLETION
2 ITERATION INTERRUPT
3 RESOURCE INTERRUPT
4 TERMINATED BY SOLVER
5 EVALUATION ERROR
LIMIT
6 CAPABILITY PROBLEMS
7 LICENSING PROBLEMS
8 USER INTERRUPT
9 ERROR SETUP FAILURE
10 ERROR SOLVER
FAILURE
11 ERROR INTERNAL
SOLVER FAILURE
12 SOLVE PROCESSING
SKIPPED
13 ERROR SYSTEM
FAILURE
Figure 41 – Status Report
Description
This means that the solver terminated in a normal way: i.e., it was not
interrupted by an iteration or resource limit or by internal difficulties.
This means that the solver was interrupted because it used too many
iterations. Use ‘option iterlim ‘ to increase the iteration limit if everything
seems normal.
This means that the solver was interrupted because it used too much time.
Use ‘option reslim’ to increase the time limit if everything seems normal
This means that the solver encountered difficulty and was unable to continue.
More detail will appear following the message.
Too many evaluations of nonlinear terms at undefined values. You should use
bounds to prevent forbidden operations, such as division by zero. The rows in
which the errors occur are listed just before the solution.
The solver does not have the capability required by the model, for example,
BARON has a more limited set of functions than other solvers.
The solver cannot find the appropriate license key needed to use a specific
subsolver.
The user has sent a message to interrupt the solver via the interrupt button in
the IDE or sending a control C from a command line.
The solver encountered a fatal failure during problem set-up time.
The solver encountered a fatal error.
The solver encountered an internal fatal error.
The entire solve step has been skipped. This happens if execution errors were
encountered and the GAMS parameter ExeErr has been set to a nonzero
value, or the property MaxExecError has a nonzero value.
This indicates a completely unknown or unexpected error condition.
23
The model status describes the characteristics of the accompanying solution. Usual linear programming
termination states are 1 OPTIMAL, 3 UNBOUNDED, 4 INFEASIBLE, while in non-linear
programming, the status to look for is 2 LOCALLY OPTIMAL.
If solver and model status are acceptable results of the model can be examined. Otherwise, the problem
must be solved working on the model structure in the input file.

4.6. Results
Results are split up into three sections. The are:
- Equations, indicated with solEQU in the output file;
- Variables, indicated with solVAR in the output file;
- Report summary.
For equations and variables there is a line of printout giving the lower limit, level, upper limit, and
marginal.
Results are in the Variable part.
Figure 42 shows solEQU for our example.

Figure 42 - solEQU

It is organized into three parts, each of them related to one equation in the model. The values in the
LOWER and UPPER columns are obtained from the constant right-hand-side value of the equation, as shown in
the Equation listing, which for clarity reasons is reported in the following for demand equation:

---- DEMAND =E= Demand equation

DEMAND(Meat).. D(Meat) + 0.804*P(Meat) =E= 1.07
DEMAND(Fish).. D(Fish) + 3.09*P(Fish) =E= 1.012

24
LEVEL and MARGINAL VALUE are determined by the solver. LEVEL represents the optimal level
for the equation, which is equal to the level of all terms involving variables (VERIFY IF IT IS THE
RESULT OF THE CALIBRATION PROCEDURE). The MARGINAL value of each equation is
instead equal to the resulting value of the corresponding variable.
As previously underlined, the solution of the model is in solVAR, which in our example is structured as
reported in Figure 43.

Figure 43 - solVAR

The solution level for the variables of the model is in the column LEVEL.
LOWER and UPPER limits reflect what has been declare in the model. In our example all variables are
declared as (FREE) VARIABLES and for this reason the upper and lower bound is unlimited, with the
GAMS syntax –INF and +INF.
Concerning the language rules, a single dot (.) means zero while EPS very small but nonzero.
MARGINAL is the current reduced cost to force a variable in the solution. Generally it does not have
much meaning in a MCP or CNS model.
For models that are not solved to optimality, some constraints may additionally be marked with specific
notations. They are listed and described in Table 9.

25
Table 9 – Notations for models not solved to optimality
Syntax Description

INFES The row or column is infeasible. This mark is made for any entry whose level value
is not between the upper and lower bounds.
NOPT The row or column is non-optimal. This mark is made for any non-basic entries for
which the marginal sign is incorrect.
UNBND The row or column that appears to cause the problem to be unbounded.

Results end with a Report Summary. It gives information on the total number of non-optimal, infeasible, and
unbounded rows and columns, as in Figure 44 for our example.

Figure 44 – Report Summary

The desired value is zero for all the elements.

26
 5
Demand analysis

5.1. Introduction
This Chapter introduce how to model demand with GAMS. It starts with a succinct presentation of the
theoretical concepts that find application in the modelling section. More precisely, the focus is on the
concept of demand, the objective of demand analysis and the presentation of a selection of functional
forms. Afterwards, the introduced theoretical concepts are applied in a group of models solved for the
base run. These latter are structured in order to work with some preliminary GAMS components mainly
aimed at explaining how to write in GAMS’ language the basic structure of a model. This Chapter also
introduces the steps to be followed in writing a model with GAMS.

5.2. Demand
Demand refers to the amount of a given product that consumers are willing and able to purchase, over
a certain period of time. Factors affecting consumer demand are:
- Price (P) of the demanded product (i);
- Price of related goods (j);
- Income of consumers (Y);
- Consumer preferences, such as age, education, professional status, and geographic environment and
other factors (demographic characteristics, such as population size, and expectations) (T).

In mathematical notation, they can be represented in a demand function by:

Di = f (Pi , Pj , Y , T ) (…)
where D is the quantity demanded of good i.
In this context, the objective of the demand analysis is the explanation of the level of demand for
commodities an individual or group of individuals consume, given the above mentioned factors
affecting demand.
27
Demand analysis requires the knowledge of
- How much factors affect consumer demand, an information provided by the elasticity;
- The relationship between factors affecting consumer demand and consumer demand, an indication
provided by the functional form of demand function.
These issues are discussed in the next two paragraphs.

5.3. Elasticity
According to the factor affecting demand, a specific typology of elasticity finds definition, as illustrated
in Table 10.
Table 10 – Factors affecting demand and elasticity typology
Factor affecting demand Elasticity type
Price of the demanded product Own-price elasticity of demand
Price of related goods Cross-price elasticity of demand
Income of consumers Income elasticity of demand
Consumer preferences Consumer preferences elasticity of
demand

The own-price elasticity measures the percentage change in the quantity demanded given a one percent
change in its price. According to theory, holding constant all the other factors the higher the price of the
product the less consumers are willing to buy. This is the so called low of demand, which suggests a
negative relationship between price and demand of a good: the own-price elasticity has a negative sign.
According to sign and magnitude of the own-price elasticity, demand can be classified in the typologies
listed in Table 11.
Cross-price elasticity indicates the percentage change in the quantity demanded of a good (i) given a
one percent change in the price of another related good (j).
According to the sign of the cross-price elasticity the categories of goods listed in Table 12 can be
distinguished.
Income elasticity of demand measures the percentage change in demand for a good when income
changes by one percent. Table 13 lists the categories of goods according to the sign and magnitude of
this type of elasticity.

28
Table 11 – Own-price elasticity
Value Descriptive terms Meaning

Ed = 0 Perfectly inelastic demand When quantity demanded does not change to the
percentage change in price
-1<E d <0 Inelastic or relatively inelastic when the percentage change in quantity
demand demanded is less than the percentage change in
price
E d = -1 Unit elastic, unit elasticity, when the percentage change in quantity
unitary elasticity, or unitarily demanded is equal to the percentage change in
elastic demand price
-∞<E d <-1 Elastic or relatively elastic when the percentage change in quantity
demand demanded is greater than the percentage change
in price
E d =-∞ Perfectly elastic demand Any increase in the price, no matter how small,
will cause demand for the good to drop to zero
E d >0 Giffen good Consumers paradoxically consume more as the
price rises (violation of the law of demand)

Table 12 – Categories of goods according to the sign of the cross-price elasticity

Value Definition Description

E ij < 0 Gross complements An increase in price of a good causes a decrease in demand

of the other good
E ij > 0 Gross substitutes An increase in price of a good causes an increase in demand
of the other good
E ij = 0 Independent Demand for a good is independent on the price (demand) for
other goods

Table 13 – Categories of goods according to the sign of the income elasticity of demand
Value Definition Description

EY < 0 Inferior good An increase in income causes a decrease in demand for

the good
0<E Y < 1 Normal good: Necessity good An increase in income causes a less than proportional
increase in demand for the good
EY > 1 Normal good: Superior or An increase in income causes a more than proportional
luxury good increase in demand for the good
EY = 0 Neutral good An increase in income does not causes any increase in
demand for the good

29
Even if prices and incomes are the same two or more consumers may differ in their demand due to
different preferences. The specific effect on demand is measured by the so called consumer preferences
elasticity of demand.

5.4. Functional forms

The functional forms of the demand function can be defined following two different approaches:
- The specification of a single-equation demand function in a pragmatic fashion; or
- Using theory as a guideline and passing to a complete system of demand equations.
According to the pragmatic approach, the demand function can be specified in natural logarithms (ln)
as follows:
𝑝𝑝𝑖𝑖 𝑝𝑝𝑗𝑗 𝑦𝑦
𝑙𝑙𝑙𝑙(𝑞𝑞𝑖𝑖 ) = 𝑎𝑎𝑖𝑖 + 𝑐𝑐𝑖𝑖 𝑙𝑙𝑙𝑙 � � + � 𝑑𝑑𝑗𝑗 𝑙𝑙𝑙𝑙 � � + 𝑒𝑒𝑗𝑗 ln � � + � 𝑓𝑓𝑘𝑘 𝑙𝑙𝑙𝑙(𝑧𝑧𝑘𝑘 )
𝑃𝑃 𝑃𝑃 𝑃𝑃
𝑗𝑗≠𝑖𝑖 𝑘𝑘

with q i the per capita quantity demanded (purchased) of good “i”, a i the intercept of demand function,
c i the own-price elasticity of good “i”, p i the price of the demanded good “i”, P the consumer price
index, d j the cross-price elasticities, p j the price of other good “j”, e i the income elasticity of demand, y
the total expenditure per capita, f k the preferences elasticities, z k the consumer preferences.
Dividing prices and income by the consumer price index, demand equation is homogeneous of degree
zero in prices and income. In other words, there is no money illusion: demand is not affected by a
proportional increase in all prices and income.
This approach is attractive in its simplicity but it has three major drawbacks.
First, the choice of the functional form for the demand function and the variables to be included is
arbitrary and for this reason they might not reflect the actual consumer behavior.
Second, elasticities are postulated to be constant over all values of the exogenous variables. The
assumption might not be always sustainable, such as in the case of commodities that are luxuries and
that become necessity at the increase in per capita income.
Third, the pragmatic approach does not consider the consumer budget constraint, which limits total
expenditure, as suggested by theory.
When the price of the demanded and related goods is not available, the pragmatic approach uses the
Engel function. Table 14 provides a list of functional form for this demand function.

30
 Table 14 – Engle function
Engel curve Mathematical formulation
Linear q i =a i +e i* y
Double logarithmic ln(q i )=a i +e i* ln(y)
Semilogarithmic q i =a i +e i* ln(y)
Logarithmic reciprocal ln(q i )=a i -e i* (1/y)

5.4.1. Demand systems

The most frequently adopted demand functions that reflect theoretical prescriptions are:
- Linear Expenditure System (LES);
- Almost Ideal Standard System (AIDS).
The Linear Expenditure System takes the following form:

𝑝𝑝𝑖𝑖 𝑞𝑞𝑖𝑖 = 𝑠𝑠𝑖𝑖 𝑝𝑝𝑖𝑖 + 𝑏𝑏𝑖𝑖 �𝑦𝑦 − � 𝑠𝑠𝑗𝑗 𝑝𝑝𝑗𝑗 � 𝑖𝑖 = 1, … , 𝑛𝑛

𝑗𝑗

with n the number of commodities demanded, p i the price of demanded good “i”, q i the demanded
quantity (purchased) of good “i” per capita, y the total expenditure, s i the minimum subsistence or
“committed” quantities below which consumption cannot fall and b i the marginal budget share.
This latter is defined as
∆𝑝𝑝𝑖𝑖 ∗ 𝑞𝑞𝑖𝑖
𝑏𝑏𝑖𝑖 =
∆𝑦𝑦
and expresses how expenditure on each commodity changes as income changes.
In the model the component �∑𝑗𝑗 𝑠𝑠𝑗𝑗 𝑝𝑝𝑗𝑗 � represents the subsistence expenditure, while �𝑦𝑦 − ∑𝑗𝑗 𝑠𝑠𝑗𝑗 𝑝𝑝𝑗𝑗 � is
the uncommitted or “supernumerary” income that is the share of income is spent in fixed proportions b i
between the n goods.
The interpretation of the model is that consumers spend a committed amount on each good and, after
that, divide the remaining uncommitted income among all products in fixed amounts b i .
As LES assumes b i >0, this system does not allow for inferior goods, an assumption that is not
supported by empirics; it implies a linear Engel function.
The Almost Ideal Standard System (AIDS) allows overcoming this issue introducing flexibility to the
estimated elasticities. An additional advantage of this demand model is that, as supported by demand
31
theory, it consistently considers the mutual interdependence of large numbers of commodities in the
choice made by consumers.
An AIDS is specified as follows:
𝑝𝑝𝑖𝑖 𝑞𝑞𝑖𝑖 𝑦𝑦
= 𝑎𝑎𝑖𝑖 + � 𝑑𝑑𝑖𝑖,𝑗𝑗 𝑙𝑙𝑙𝑙�𝑝𝑝𝑗𝑗 � + 𝑒𝑒𝑖𝑖 𝑙𝑙𝑙𝑙 � �
𝑦𝑦 𝑃𝑃
𝑗𝑗

with n the number of commodities demanded, p i the price of demanded good “i”, q i the demanded
quantity (purchased) of good “i” per capita, y the total expenditure, a i the intercept of demand function,
d j the cross-price elasticities, p j the price of other good “j”, e i the income elasticity of demand, and P
the consumer price index.
𝑝𝑝𝑖𝑖 𝑞𝑞𝑖𝑖
𝑦𝑦
is the budget share, that is the share if income spent in good “i”.

32