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Equilibrium Modeling

Equilibrium modeling, which also refers to the computable general equilibrium (CGE) model or applied general equilibrium (AGE) model, is a quantitative method primarily used for economic and policy impact analysis. The method has gained increasing attention and interest in recent decades due to the development of computer technology. In the field of transportation, equilibrium modeling has been extensively used to evaluate social, economic, and environmental impacts of infrastructure investment as well as various transportation-related price policies. This introduction to equilibrium modeling covers its definition, history, data, method, model types, implementation, and limitations.

Definition

General equilibrium model is a comprehensive economic model that uses actual economic data to estimate interactions between the economy and the changes in policy, technology, or other external factors. Unlike partial equilibrium modeling, general equilibrium modeling presents a more comprehensive impact assessment because both the demand and the supply of an economy are considered simultaneously in a system of equations with linkages through price and quantity of commodities. The model is built based on the Walras-Arrow-Debreu theory of general equilibrium, with modern modifications and extensions allowing for imperfect markets. Because CGE provides clear linkages between the microeconomic structure and the macroeconomic environment, the model can be applied to simulate the interrelationships among multiple industrial sectors and markets. More importantly, it can be used to assess direct, indirect, and induced effects from the change of public policy on various economic variables such as industrial outputs, employment, prices of commodities and factors, household income, and social welfare.

In CGE models, different economic agents, such as consumer, producer, government, investment, and the rest of the world, are usually included in the general equilibrium framework. Economic linkages between agents are established and modeled through simultaneous equations. A final solution for the equation systems is found through an algorithm of calculation under the condition of a general equilibrium. To achieve the impact assessment, a new equilibrium solution is calculated based on revised or adjusted policy inputs or parameters. Impact variations can be measured by the differences of outputs between the new equilibrium and the prior base equilibrium.

History

The first CGE model was developed by the Norwegian economist Leif Johansen in 1960. His model is distinguished from traditional economic models in that the economic behaviors of different agents are modeled separately but with coordination through prices and quantities determined by interaction of demand and supply. In the 1970s, the American economist Herbert Scarf further improved the equilibrium modeling techniques by developing a mathematic algorithm for computing solutions to numerically specified general equilibrium models. His contribution is the design of the finite convergence approach that makes the computational process of equilibrium modeling achievable in a finite numbers of steps. After 1980, interest in equilibrium modeling expanded as applied researchers began to appreciate the power of optimizing assumptions that translated broad experience into plausible predictions of particular shock effects. In addition, the development of computer technology as well as improvement of economic data collection made CGE analysis much easier than before. In terms of modeling capacity, it is now possible to conduct a CGE analysis with 500 industries, 50 regions, and 700 occupations.

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