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Economics 216 The Macroeconomics of Economic Development. Lawrence J. Lau, Ph. D. Kwoh-Ting Li Professor of Economic Development Department of Economics Stanford University Stanford, CA 94305-6072, U.S.A. Winter, 1999-2000 Phone: 1-650-723-3708; Fax: 1-650-723-7145 - PowerPoint PPT Presentation
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Economics 216The Macroeconomics ofEconomic Development
Lawrence J. Lau, Ph. D.
Kwoh-Ting Li Professor of Economic DevelopmentDepartment of Economics
Stanford UniversityStanford, CA 94305-6072, U.S.A.
Winter, 1999-2000
Phone: 1-650-723-3708; Fax: 1-650-723-7145Email: [email protected]; Website: www.stanford.edu/~ljlau
Lecture 15Applied General Equilibrium Models
Lawrence J. Lau, Ph. D.
Kwoh-Ting Li Professor of Economic DevelopmentDepartment of Economics
Stanford UniversityStanford, CA 94305-6072, U.S.A.
Winter, 1999-2000
Lawrence J. Lau, Stanford University
3
General Equilibrium Models of the Economy Under the assumptions of:
(1) concave technologies; (2) quasiconcave preferences; (3) price-taking behavior (4) profit maximization by producers; (5) utility maximization by households.
Characterization of a competitive general equilibrium (Excess demand is less than or equal to zero in every market): Existence Uniqueness Optimality
Lawrence J. Lau, Stanford University
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General Equilibrium Models of the Economy Welfare Theorem: A competitive general equilibrium is
efficient Converse Theorem: An efficient allocation can be realized
as a competitive general equilibrium
Lawrence J. Lau, Stanford University
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Why is Partial Equilibrium Analysis not Enough? Everything depends on everything else Other things are not equal
Example: A given policy measure may change both the supply and the demand sides with the outcome on both the equilibrium price and quantity not easily predictable a priori
Lawrence J. Lau, Stanford University
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Why Applied (Computable) General Equilibrium (CGE) Models? Analytical indeterminacy of effects Need to know magnitude as well as direction Analytical intractability--substitution of numerical
simulation for analysis Sensitivity analysis
Lawrence J. Lau, Stanford University
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A Simple Static Applied General Equilibrium Model: Specification Economic agents
Households (utility functions) Firms (production functions)
Goods and factors Initial Endowments
Leisure Inventory Capital
Behavior Utility maximization Profit maximization
Markets Simultaneous clearing with zero excess demand of all goods
Lawrence J. Lau, Stanford University
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A Simple Static Applied General Equilibrium Model: Specification Choice of a numeraire good (zero degree homogeneity) Choice of assumptions on the utility and production
functions Choice of functional forms for utility and production
functions
Lawrence J. Lau, Stanford University
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Specification Households (Preferences)
Demander of goods for consumption Supplier of labor Supplier of saving Owner of capital
Firms (Technologies) Demander of capital Demander of labor Supplier of goods for consumption and investment
Lawrence J. Lau, Stanford University
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Specification There is no government, no external sector, no money and
no financial sector
Lawrence J. Lau, Stanford University
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The Simplest System of Equations
Households
Demand for consumption = DC (r*, w*, K-1, SS)
Supply of labor = SL (r*, w*, K-1, SS)
Supply of savings = SS (exogenously given)
Firms
Demand for capital = DK (r*, w*)
Demand for labor = DL (r*, w*)
Supply of output = SO (r*, w*)
Lawrence J. Lau, Stanford University
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General Equilibrium
General Equilibrium
Demand for capital = DK (r*, w*) = Supply of capital = K-1
Demand for labor =DL (r*, w*)=Supply of labor= SL (r*, w*, K-1, SS)
Supply of output = SO (r*, w*) = Demand for consumption+Savings
= DC (r*, w*, K-1, SS) + SS
Lawrence J. Lau, Stanford University
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Determination of the Parameters:Calibration versus Econometric Estimation The derivation of the numerical values of the parameters The calibration approach
matching quantities and prices in the base period overly dependent on assumptions on the functional forms
The econometric approach estimating parameters on the basis of a time-series of
observations permits validation of estimated values of parameters with actual
empirical experience functional form and other assumptions can be empirically tested
Lawrence J. Lau, Stanford University
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Solution of the Model:The Choice of Algorithms Fixed point algorithms (Scarf)
Lawrence J. Lau, Stanford University
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Welfare Analysis Compensating variations--the sum of additional consumer
expenditures required in order to achieve the old levels of utilities at the new prices
Equivalent variations--the sum of the additional consumer expenditures required in order to achieve the new levels of utilities at the old prices
The social welfare function (interpersonal comparison of utilities required)
Lawrence J. Lau, Stanford University
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Extension to Multiple Periods A sequence of static general equilibria linked by
endogenously determined savings and investments The rate of time preference (choice between present and
future consumption) The assumption of intertemporal separability
U(C1, C2, …, CT) = Ut (Ct)
Lawrence J. Lau, Stanford University
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The Importance of the Terminal Conditions For finite horizon models, it will be optimal to allow the
capital stock to go to zero at the terminal point, which cannot possibly correspond to a real world situation
The terminal conditions have a significant impact on the simulation results
Solutions: Infinite horizon (steady-state) models Ad hoc savings function
Lawrence J. Lau, Stanford University
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The Role of Rational Expectations A rational expectations general equilibrium implies that the
prices in every period must be ex ante anticipated by the economic agents
A backward recursive solution algorithm is required
Lawrence J. Lau, Stanford University
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Extension to Open Economies Trade (Exports and Imports) Foreign direct investment Foreign portfolio investment, loans and aid Tariffs, quotas, and other non-tariff barriers The exchange rate Technology transfer
Lawrence J. Lau, Stanford University
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The Introduction of Government:Expenditures and Taxes Government expenditure (public consumption) can be
treated as an argument in the utility function Government can also be treated as an independent
economic agent, with its own objective function and behavioral assumptions
Government expenditures and public capital stocks may affect both the consumption behavior of households and production behavior of firms
Likewise, government taxation may also affect both the consumption behavior of households and production and investment behavior of firms
Lawrence J. Lau, Stanford University
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The Introduction of Money and the Financial Sector The neutrality of money--the absence of money illusion (Is
it true?) Does indexing have an impact? (it may depend on
anticipations/expectations) The “Cash-in-Advance” Constraint
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The Possibility of Multiple Equilibria Multiple equilibria are possible
“flat” indifference surfaces rational expectations equilibria
Rank-ordering multiple equilibria
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The Importance of Sensitivity Analysis The robustness of the simulation results must be tested
with sensitivity analysis
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The Role of Uncertainty:Incompleteness of Markets Availability of futures markets Availability of insurance markets Availability of contingent markets