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Simulation Models: Issues,
Design, and Implementation
Institute of Development Studies
University of Sussex
• Long history in economics
– Models used in “simulation mode”
– Models designed for simulation
• Level of aggregation
– World models
– Country models
– Regional/sub-regional models
– Enterprise/farm models
Commodity Market Models
• Single commodity or multimarket
– Partial equilibrium models
• Supply and demand curves
– Linear or nonlinear
– Expenditure functions may or may not be based
on demand theory
• “Economy” may vary in size and domain
– Macro models: macro aggregates
– General equilibrium market models
• Fixed prices: multiplier models
• Flexible prices: market interactions
• CGE models: agents interacting across markets
– Microsimulation household models
• Agents and “markets” within a household
• Agents and interactions in model economy
Model Design: Simplicity
– “putting numbers to theory”
– Focus on particular issue
– Larger, more detail (including institutions)
– Cover many issues
• Principle of Occam’s Razor
– Simplest model adequate to the task
Model Design: Theory
• Walras, neoclassical, structuralist,
– Role of product and factor markets.
– Role of assets and financial markets.
• Dynamic versus static.
– Time horizon: short, medium, long.
Model Design: Structure
• “Deep” structural models.
– Specify agents, markets, institutions, signals,
motivation, and behavior.
• “Shallow” or “reduced form” models.
– Vague theoretical specification of relationships
– Unidentified/unidentifiable underlying structural
• “Economywide” model with many markets:
factors and commodities
– Simultaneous equilibrium across inter-dependent
• “Behavior” from general equilibrium theory
– Maximizing agents in competitive markets
• Constrained by technology and income
– Agents react to price signals
Stylized CGE Model Structure
Factor Domestic Private Savings
Factor Markets Wages
Costs & Rents Gov. Savings
Input Cost Households Government Sav./Inv.
Private Government Investment
Consumption Consumption Demand
Exports Imports Foreign Transfers
Rest of the Foreign Savings
Receipts Domestic Rest of
Activities Commodities Factors Totals
Market Home con- Activity
sales sumption income
Commodities actions market Exports
Domestic Tariffs, Income, Transfers, Institution
Institutions Taxes Taxes Savings income
Activity Commodity Factor Institution
spending supply spending spending
• Role of statistics/econometrics.
– Nature of prior information.
• Shallow reduced form models.
– Very little prior information about parameters. Not
– Need lots of data.
– Appropriate use of standard econometric methods
for parameter estimation.
• Deep structural model.
– Much more prior information about parameter
values, based on theory and knowledge of model
– Usually more parameters to estimate, and data
– Appropriate setting for Bayesian and maximum
entropy econometric methods.