Simulation Models: Issues, Design, and Implementation

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IFPRI - ESSP2 and EDRI: Insights from Computable General Equilibrium (CGE) Analysis. Hilton, Addis Ababa, November 18, 2009

IFPRI - ESSP2 and EDRI: Insights from Computable General Equilibrium (CGE) Analysis. Hilton, Addis Ababa, November 18, 2009

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  • 1. Simulation Models: Issues, Design, and Implementation Sherman Robinson Institute of Development Studies University of Sussex November 2009
  • 2. Simulation Models • 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 2
  • 3. 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 3
  • 4. Economywide Models • “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 4
  • 5. Model Design: Simplicity • Stylized – “putting numbers to theory” – Focus on particular issue • Applied – Larger, more detail (including institutions) – Cover many issues • Principle of Occam’s Razor – Simplest model adequate to the task 5
  • 6. Model Design: Theory • Walras, neoclassical, structuralist, Keynes. – Role of product and factor markets. – Role of assets and financial markets. • Dynamic versus static. – Time horizon: short, medium, long. 6
  • 7. Model Design: Notions of Equilibrium • Flow equilibria – Many product and factor markets – Macro flows: G-T, S-I, M-E – Loanable funds market • Asset markets: equilibrium stock holding • Intertemporal equilibrium: expectations – Forward-looking agents – Rational expectations 7
  • 8. Model Design: Structure • “Deep” structural models. – Specify agents, markets, institutions, signals, motivation, and behavior. • “Shallow” or “reduced form” models. – Vague theoretical specification of relationships among variables. – Unidentified/unidentifiable underlying structural model. 8
  • 9. CGE Models • “Economywide” model with many markets: factors and commodities – Simultaneous equilibrium across inter-dependent markets • “Behavior” from general equilibrium theory – Maximizing agents in competitive markets • Constrained by technology and income – Agents react to price signals 9
  • 10. Stylized CGE Model Structure Factor Domestic Private Savings Factor Markets Wages Costs & Rents Gov. Savings Taxes Intermediate Input Cost Households Government Sav./Inv. Activities Transfers Private Government Investment Consumption Consumption Demand Commodity Sales Markets Exports Imports Foreign Transfers Rest of the Foreign Savings World 10
  • 11. SAM Structure Expenditures Receipts Domestic Rest of Activities Commodities Factors Totals Institutions World Market Home con- Activity Activities sales sumption income Trans- Final Intermediate Commodity Commodities actions market Exports inputs demand costs demands Value Factor Factors Transfers added income Transfers, Domestic Tariffs, Income, Transfers, Institution Taxes Taxes, Institutions Taxes Taxes Savings income Savings Foreign Rest of Imports exchange World outflow Foreign Activity Commodity Factor Institution Totals exchange spending supply spending spending inflow 11
  • 12. Implementation: Estimation • Role of statistics/econometrics. – Nature of prior information. • Shallow reduced form models. – Very little prior information about parameters. Not enough theory. – Need lots of data. – Appropriate use of standard econometric methods for parameter estimation. 12
  • 13. Implementation: Estimation • Deep structural model. – Much more prior information about parameter values, based on theory and knowledge of model structure. – Usually more parameters to estimate, and data are scarce. – Appropriate setting for Bayesian and maximum entropy econometric methods. 13