Edited by Charlie Karlsson, Martin Andersson and Therese Norman
Chapter 2: Spatial computable general equilibrium analysis
Computable general equilibrium (CGE) analysis, also called applied general equilibrium analysis, is a computational method to study quantitatively the impact of exogenous changes, so-called ‘shocks’, in an economy on a wide range of variables of interest such as prices, quantities of consumption, production and trade, and – most importantly – on welfare. It has its roots in the theory of general equilibrium invented by Léon Walras and worked out mathematically by Gérard Debreu, Kenneth Arrow, Lionel McKenzie and others. The basic idea of this theory is that firms and households buy or sell goods and factors on markets that clear through flexible prices. Firms choose input and output quantities such that they maximize profits; households maximize utility subject to their respective budget constraints. In the standard model version, competition is assumed to be perfect: firms and households are price takers. The model is ‘real’ in the sense that prices are relative prices, measured in terms of an arbitrarily chosen numéraire. Money and banks are absent. The model is ‘general’, meaning that, for a closed economy, all market interactions between all agents of the economy are simultaneously taken account of. This is done in a consistent way: what an agent sells is bought by some other agent, and incomes or revenues received by any agent equal the expenditures of the respective agent.
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