Computable general equilibrium

Computable general equilibrium (CGE) models are a class of economic models that use actual economic data to estimate how an economy might react to changes in policy, technology or other external factors. CGE models are also referred to as AGE (applied general equilibrium) models.

A CGE model consists of equations describing model variables and a database (usually very detailed) consistent with these model equations. The equations tend to be neo-classical in spirit, often assuming cost-minimizing behaviour by producers, average-cost pricing, and household demands based on optimizing behaviour. However, most CGE models conform only loosely to the theoretical general equilibrium paradigm. For example, they may allow for:

A CGE model database consists of:

CGE models are descended from the input-output models pioneered by Wassily Leontief, but assign a more important role to prices. Thus, where Leontief assumed that, say, a fixed amount of labour was required to produce a ton of iron, a CGE model would normally allow wage levels to (negatively) affect labour demands.

CGE models derive too from the models for planning the economies of poorer countries constructed (usually by a foreign expert) from 1960 onwards . Compared to the Leontief model, development planning models focused more on constraints or shortages—of skilled labour, capital, or foreign exchange.

CGE modelling of richer economies descends from Leif Johansen's 1960 MSG model of Norway, and the static model developed by the Cambridge Growth Project in the UK. Both models were pragmatic in flavour, and traced variables through time. The Australian MONASH model is a modern representative of this class. Perhaps the first CGE model similar to those of today was that of Taylor and Black (1974).

CGE models are useful whenever we wish to estimate the effect of changes in one part of the economy upon the rest. For example, a tax on flour might affect bread prices, the CPI, and hence perhaps wages and employment. They have been used widely to analyse trade policy. More recently, CGE has been a popular way to estimate the economic effects of measures to reduce greenhouse gas emissions.

CGE models always contain more variables than equations—so some variables must be set outside the model. These variables are termed exogenous; the remainder, determined by the model, are called endogenous. The choice of which variables are to be exogenous is called the model closure, and may give rise to controversy. For example, some modelers hold employment and the trade balance fixed; others allow these to vary. Variables defining technology, consumer tastes, and government instruments (such as tax rates) are usually exogenous.

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