A Quick Reference Guide to CGE Modeling
This is a draft guide to building and using computational general equilibrium models. It is gradually being replaced by a more detailed version available via the link above.
Characteristics of CGE models
- Multiple interacting agents
- Behavior derived from optimization
- Multiple markets
- Often highly disaggregated
- Finds a decentralized equilibrium rather than optimizing a planner's objective function
- Designed for policy analysis
How to build a model
- Choose the number and type of agents in the model.
- Specify each agent's optimization problem.
- Solve for the behavioral equations implied by the optimization problems.
- Add market-clearing and accounting equations.
- Drop one market-clearing equation because of Walras Law.
- Choose one price to be the numeraire.
- Check that the model is closed by counting equations and variables.
- Condense the model (if necessary) to lower computational costs
- Estimate the behavioral parameters.
- Choose base-case values of exogenous variables.
- Set to historical values for counterfactual analysis
- Set to business-as-usual values for prospective analysis
- Choose an appropriate software package to solve the model.
- Write a program implementing the model.
- Write it in a form as close as possible to the underlying economics
- Include extensive comments
- Solve for the base-case equilibrium.
- Test the model thoroughly.
- Is it homogeneous in prices and wages?
- Does it satisfy Walras Law?
- Does it scale up and down correctly in quantities?
- Check any other experiments whose results can be predicted.
How to use a model for policy analysis
- Decide how to express the policy in terms of the model's variables.
- Think about what the policy could be expected to do to the economy.
- Ideally, do analytical comparative statics
- Run the simulation and compare the results to the base case.
- Analyze the experiment and explain why the results come out the way they do.
- Evaluate the policy
- Equivalent variation is strongly preferred to GDP as a welfare measure
- Determine confidence intervals for the results.
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Peter J Wilcoxen, The Maxwell School, Syracuse University