Building a CGE Model for Economic and Environmental Policies

Abstract

To perform a joint analysis of economic and environmental policy (which will be done in the coming chapters), we need to build a model that includes information about both the key economic variables and the environmental impact of economic activity. In this chapter we introduce the standard structure of the CGE model (following the Walrasian tradition) that we use for this task. We present the technological structure, represented by a nested production function. Concerning consumer behaviour, we include a single representative consumer that makes decisions about consumption and saving while trying to maximize his/her utility function subject to a budget constraint. Pollutant emissions are introduced following a short-term approach according to which pollution intensity is assumed to be fixed. We provide for the possibility that the government imposes emissions charges on top of other taxes. The basic structure of the model is completed with a description of input markets, the foreign sector (whose behaviour is assumed to be exogenous) and the closure rule which links investment, saving and the public and foreign balances. We also introduce the main database used for the calibration process, which is Spain’s social accounting matrix.