Simulation Models: Issues,

Design, and Implementation

Sherman Robinson

Institute of Development Studies

University of Sussex

November 2009

2

Simulation Models

• Long history in economics

– Models used in “simulation mode”

– Models designed for simulation

• Level of aggregation

– World models

– Country models

– Regional/sub-regional models

– Enterprise/farm models

3

Commodity Market Models

• Single commodity or multimarket

– Partial equilibrium models

• Supply and demand curves

– Linear or nonlinear

– Expenditure functions may or may not be based

on demand theory

4

Economywide Models

• “Economy” may vary in size and domain

– Macro models: macro aggregates

– General equilibrium market models• Fixed prices: multiplier models

• Flexible prices: market interactions

• CGE models: agents interacting across markets

– Microsimulation household models• Agents and “markets” within a household

• Agents and interactions in model economy

5

Model Design: Simplicity

• Stylized

– “putting numbers to theory”

– Focus on particular issue

• Applied

– Larger, more detail (including institutions)

– Cover many issues

• Principle of Occam’s Razor

– Simplest model adequate to the task

6

Model Design: Theory

• Walras, neoclassical, structuralist,

Keynes.

– Role of product and factor markets.

– Role of assets and financial markets.

• Dynamic versus static.

– Time horizon: short, medium, long.

7

Model Design:

Notions of Equilibrium

• Flow equilibria

– Many product and factor markets

– Macro flows: G-T, S-I, M-E

– Loanable funds market

• Asset markets: equilibrium stock holding

• Intertemporal equilibrium: expectations

– Forward-looking agents

– Rational expectations

8

Model Design: Structure

• “Deep” structural models.

– Specify agents, markets, institutions, signals,

motivation, and behavior.

• “Shallow” or “reduced form” models.

– Vague theoretical specification of relationships

among variables.

– Unidentified/unidentifiable underlying structural

model.

9

CGE Models

• “Economywide” model with many markets:

factors and commodities

– Simultaneous equilibrium across inter-dependent

markets

• “Behavior” from general equilibrium theory

– Maximizing agents in competitive markets

• Constrained by technology and income

– Agents react to price signals

10

Stylized CGE Model Structure

Activities

Commodity Markets

Factor

Markets

Rest of the World

Households Government Sav./Inv.

FactorCosts

Wages& Rents

Intermediate

Input Cost

Sales

PrivateConsumption

Taxes

Domestic Private Savings

Government

Consumption

Gov. Savings

Investment

Demand

ImportsExports

Foreign Savings

Transfers

Foreign Transfers

11

SAM Structure

Expenditures Receipts

Activities Commodities Factors Domestic

Institutions Rest of World

Totals

Activities Market sales

Home con- sumption

Activity income

Commodities

Intermediate

inputs

Trans- actions costs

Final

market demands

Exports Commodity

demand

Factors Value added

Transfers Factor income

Domestic Institutions

Taxes Tariffs, Taxes

Income, Taxes

Transfers, Taxes, Savings

Transfers, Savings

Institution income

Rest of World

Imports Foreign

exchange outflow

Totals Activity

spending Commodity

supply Factor

spending Institution spending

Foreign exchange

inflow

12

Implementation: Estimation

• Role of statistics/econometrics.

– Nature of prior information.

• Shallow reduced form models.

– Very little prior information about parameters. Not enough theory.

– Need lots of data.

– Appropriate use of standard econometric methods for parameter estimation.

13

Implementation: Estimation

• Deep structural model.

– Much more prior information about parameter

values, based on theory and knowledge of model

structure.

– Usually more parameters to estimate, and data

are scarce.

– Appropriate setting for Bayesian and maximum

entropy econometric methods.