Shoven and Whalley: Applying General Equilibrium

Shoven, John B, and John Whalley. 1992. Applying General Equilibrium. Cambridge University Press.

“A general equilibrium model of an economy can be best understood as one in which there are markets for each of N commodities, and consistent optimization occurs as part of equilibrium. Consumers maximize utility subject to their budget constraint, leading to demand-side specification of the model. Producers maximize profits, leading to the production-side specification. In equilibrium, market prices are such that the required equilibrium conditions hold. Demand equals supply for all commodities, and in the constant-returns-to-scale case zero-profit conditions are satisfied for each industry” (9).

“The applied general equilibrium models in operation today differ substantially from one another. Some are large-scale multipurpose models; others, small-scale issue-specific models. They vary in their country of application, use of functional forms, and treatment of such issues as time, foreign trade, and the government sector. Their use of data and parameter values also varies” (71).

“Although the general equilibrium model appropriate for any particular application depends largely on the policy issues being addressed, most applied models currently in use have a similar form. They are typically variants of static, two-factor models that have long been employed in public finance and international trade…Most models involve more than two goods, while aggregating the factors of production into two broad types—capital and labor” (92).

“Choice of the level of aggregation for an applied model is one of the more difficult design issues that any prospective modeler must confront. ON the one hand, there is the natural desire to make the model as detailed as possible in the belief that this will increase its realism. On the other hand, more detail is not always beneficial; much of it may prove superfluous to the issues at hand: (100).