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  • Print publication year: 2017
  • Online publication date: February 2017

4 - Final Demand in a CGE Model

Summary

In this chapter, we describe final demand by domestic agents – private households, government, and investors – and by the export market. Data in the Social Accounting Matrix (SAM) describe agents’ incomes and the commodity composition of their spending. The computable general equilibrium (CGE) model depicts demand by domestic agents as a two-stage decision. First, consumers decide on the quantities of each commodity in their consumption basket. Second, an “Armington” import aggregation function describes their choice between domestic and imported varieties of each commodity. We survey functional forms commonly used in CGE models to describe private household preferences. We also introduce the concept of “national welfare,” which is the monetary value of changes in a nation's well-being following an economic shock.

The U.S. economic stimulus package, implemented in the 2009 recession, was designed to increase government spending in order to compensate for sharp declines in spending by private households and investors, and in export sales. These four categories of demand – private households, investment, government, and exports – constitute the demand side of an economy. They are called components of final demand, since the goods and services that are consumed are in their end-use; they are not further combined or processed into other goods and services. An economy's structure can change when the categories of aggregate final demand change in relative size, because each type of final demand usually purchases different goods and services. For example, households purchase items like groceries and entertainment, whereas investors purchase mainly machinery and equipment, and governments mostly purchase services. The increased share of the government in U.S. final demand as a result of the stimulus program thus likely changed the types of goods demanded in the U.S. economy, at least in the short term.

In this chapter, we learn how the SAM's data describe each component of final demand. We then study how each final demand agent is assumed to behave in the CGE model. Our discussion in this chapter mostly focuses on commonalities among CGE models, including the concept of “commodities,” the two- (or three-)stage budgeting decision, and the measurement of national welfare. CGE models differ widely in their descriptions of private households’ consumption behavior, making it difficult to characterize a “standard” CGE model in this respect.

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