1. The GEM-E3 Model and its extensions. Prof. P. Capros ICCS/NTUA
MODELS
The GEM-E3 Model and its extensions.
Prof. P. Capros
ICCS/NTUA

2. Objectives
To install operational versions of GEM-E3 on the computer system of the European Commission for in house use.
To support a series of policy applications with GEM- E3 on issues related to the Lisbon agenda and the assessment of impacts from regulation and legislative initiatives of the Commission.
To improve the GEM-E3 computable general equilibrium model.
March 2007

3. The GEM-E3 model.
GEM-E3 is a multi-region Computable General Equilibrium model built to evaluate the economic impacts of structural policies.
GEM-E3 provides the user with many modelling options: a European model, a World model, and a series of different model closures.
GEM-E3 is developed using GAMS and uses MS-Excel for the data and the results.
A non-developer user may run GEM-E3 after a short training, example IPTS of EC/JRC.
March 2007

4. Model Extensions
Internal Market under imperfect competition and economies of scale.
Bottom up energy sub-model and depletable energy resources mechanism.
Endogenous technical progress.
Imperfect markets for labour and capital.
March 2007

5. Model versions delivered to Commission
March 2007

6. “Internal market, competition and trade” (GEME3 v. ICT).
This version will serve as the basis for all model developments.
Standard version featuring:
Market integration and trade with imperfect competition and economies of scale
Energy and environmental module
Option for unemployment (wage curve introduction).
March 2007

7. “Endogenous Growth, Internal Market, Competition and Trade” (GEME3 – v
“Endogenous Growth, Internal Market, Competition and Trade” (GEME3 – v. EGICT).
Model with endogenous technical change.
Combines the advanced trade model version with endogenous growth driven by technology progress and innovation.
The EGICT version will be used to study:
the knowledge society,
the internal market,
the business climate and the environmental sustainability aspects of the Lisbon strategy
March 2007

8. “Social structures, Internal market, Competition and Trade” ” (GEME3 – v. SICT).
SICT version features:
disaggregated and improved labour, capital, skills and households
improved representation of the services sector and the trade for services in the Internal Market.
SICT model version enables to study:
Distributional and social impacts on employment.
Advanced analysis on double dividend issues (employment and environment).
March 2007

9. Links between model versions and Lisbon policy agenda.
The model extensions
The Knowledge Society
The Internal Market
The Business Climate
The Labour Market
Environmental Sustainability
Endogenous Technical Progress
Market Integration under imperfect competition and product varieties
Capital market and investment flows
Labour market under imperfect competition
Energy-Environment sustainability driving innovation, demand for equipment goods and exports
March 2007

10. Schedule Phase A The GEM-E3 team will: Perform the necessary updates,
Check the operation of the model,
Improve the user interface
Provide the user manual and
Install the ICT GEM-E3 version at the Commission.
Phase B
Install EGCT and SICT versions at the Commission
Finalisation of user interface
User manual provision
Provide support in designing and implementing the policy scenarios
Timeline
Month 5 : Installation of improved model version (ICT) to the Commission .
Month 17: Policy applications as per Phase A.
Month 19: Installation of final model versions to the Commission.
Month 35: End of policy applications as per Phase B.
March 2007

11. Regional and sectoral coverage (current and proposed)
GEM-E3
Regional and sectoral coverage
(current and proposed)

12. GEM-E3 Data Bases
The European version of GEM-E3 is entirely based on Eurostat statistics.
The World version of GEM-E3 is based on the GTAP-6 database which covers the whole world aggregated in 87 regions and 57 sectors (base year 2001).
March 2007

13. GEM-E3 Regional aggregation.
Proposed:
E.U. 27 (separately)
Rest of Europe
North America
Latin America and Mexico
Rest of OECD
C.I.S.
Rest of Asia
Africa Sub Sahara
Middle East and N. Africa
Current:
Oceania
Japan
East Asia
China
India
Rest of Asia
U.S.A.
Canada
Mexico & Venezuela
Latin America
E.U. 27
Other Europe
C.I.S.
Middle East
Mediterranean
South Africa
Rest of Africa
March 2007

14. GEM-E3 Sectoral aggregation
Proposed
AGRICULTURE
COAL
OIL
GAS
ELECTRICITY
NON FERROUS METALS
FERROUS METALS
CHEMICAL PRODUCTS
OTHER ENERGY INTENSIVE
ELECTRONIC EQUIPMENT
TRANSPORT EQUIPMENT
OTHER EQUIPMENT GOODS
OTHER MANUFACTURING PRODUCTS
CONSTRUCTION
FOOD INDUSTRY
TRADE AND TRANSPORT
TEXTILE INDUSTRY
COMMUNICATIONS
FINANCIAL SERVICES
INSURANCE
BUSINESS SERVICES NEC
RECREATIONAL AND OTHER SERVICES
PUBLIC ADMINISTRATION, DEFENSE, EDUCATION, HEALTH
Current
AGRICULTURE
COAL
OIL
GAS
ELECTRICITY
NON FERROUS METALS
FERROUS METALS
CHEMICAL PRODUCTS
OTHER ENERGY INTENSIVE
ELECTRONIC EQUIPMENT
TRANSPORT EQUIPMENT
OTHER EQUIPMENT GOODS
OTHER MANUFACTURING PRODUCTS
CONSTRUCTION
FOOD INDUSTRY
TRADE AND TRANSPORT
TEXTILE INDUSTRY
OTHER MARKET SERVICES
NON MARKET SERVICES
March 2007

15. WP 2.1: Internal Market and world trade under imperfect competition and economies of scale
Extension of GEM-E3

16. Basic modelling idea
Goods are differentiated by origin (Armington assumption)
Differentiation by consumers is reflected through the form of the demand nesting hierarchy.
The selling price of a good is a function of an endogenous mark-up and the eventual barriers to trade.
The mark-ups reduce when enlarging the market, as a result of more intensive competition.
March 2007

17. Supply Technologies Calibration Entry/exit of firms
Minimum Efficient Scale
Cost Gradient (engineering studies)
Number of equivalent equal size firms from Herfindahl index
Calibration of mark-up
Entry/exit of firms
Symmetric firms
Number of firms endogenous
To ensure zero profits or non-zero profits (optional)
Endogenous mark-ups
Depending on concentration
Depending on average cost
March 2007

18. Demand nesting hierarchy
Structural changes such as the EU Internal Market
March 2007

19. The love of variety effect
Hypothesis about horizontal product differentiation between firms within the same sector and country
When varieties increase, the consumer obtains the same aggregate quantity more efficiently (i.e. with lower quantities hence lower cost)
This relaxes short-term supply constraints, leading to lower market prices and magnifies the effect of market enlargement
The number of varieties increase with more intensive competition as the effect from the market enlargement dominates over the effect from market concentration.
March 2007

20. Imperfect competition
Various modelling options (Cournot, monopolistic competition, Ramsey-Boiteux pricing, etc.)
In any case the market price depends on costs and an endogenous mark-up:
Under free entry/exit of firms, the number of firms adjusts in a sector, depending also on the efficient size of company as related to the market size.
Enlargement leads to increase of number of firms hence varieties and a reduction of the mark-ups
March 2007

21. WP 2.2: Engineering economic model integration for the energy and environment systems
Extensions of GEM-E3:
- Engineering oriented energy sub-model
- Depletable energy resources
- Endogenous energy efficiency and savings
- Environmental impact sub-model
- Sub-model for cost-benefit environmental assessment
- Double dividend analysis: environment and employment

22. Basic modelling idea
The core GEM-E3 already covers energy issues and the interactions with the environment
Linkage to a detailed environmental sub-model
Calibration to energy projections by PRIMES and POLES.
However, the core model lacks
Discrete representation of power producing technologies.
Non-linear (decreasing return to scale) mechanism for the supply of energy resources, such as the depletable fossil fuels.
March 2007

23. Bottom-up for power generation
Explicitly represents a variety of old and new technologies of power generation.
Endogenous investment into new power generation plants.
Energy investment is linked to the demand for equipment goods.
Technology progress incorporated through the capital vintages.
Emissions from power generation linked to the environmental sub-model and policy instruments influence power sector decisions.
March 2007

24. Bottom-up for power generation
Dispatching under capacity constraints
Investment in new power plants
Price of electricity – options
Mark-up (under IC)
Ramsey-Boiteux to recover fixed costs
Influenced by
Fuel and technology costs
Environmental policies
March 2007

25. Depletable energy resources
The price of energy resources become a function of
The rate of extraction from proven reserves and the rate of discovery of new reserves.
The accumulated use of the resources
The reserves are introduced as a separate production factor.
In the presence of climate change policies, abatement costs increase as a result of lower fossil fuel prices related to lower demand; opposite effects in case of dash for gas.
March 2007

26. Endogenous energy savings
Endogenous decision to invest in energy saving equipment.
Production and consumption functions are extended with the energy saving considered as an additional factor
Energy saving draws from a limited potential for savings per sector, hence follows decreasing return to scale
Investment in energy saving induces expenses taken into account in the least cost decision of the agent.
The purchase of goods to implement energy saving influences total demand for goods and services
March 2007

27. WP 2.3: Endogenous Growth through technology and innovation
Extension of GEM-E3

28. Basic modelling idea Combination of two production functions:
Knowledge production function: generation of new innovation
Output production function: standard KLEM function extended to account for the impact of endogenous technology innovation
March 2007

29. Endogenous innovation: supply
Main modelling hypothesis:
R&D investment of firms show decreasing return to scale with accumulated knowledge
Spillovers represented as positive externality leading to higher productivity of R&D expenditure
The combination determines the supply function of innovations (price and quantity locus)
Public R&D subsidies support innovation but are subject to the effects from GE budget constraint
March 2007

30. Endogenous Innovation: demand
Decision of a firm to purchase innovation:
Endogenous, positively affects productivity of factors but induces expenditure
Applies to the new capital vintage
Simultaneously with the demand for all production factors (L,E,M) and productive investment, so as to maximise expected net present value of the firm
In the model dynamics depends on firm sales expectations and the unit costs of factors
March 2007

31. Sub Package 2.4: Model improvement of labour market, households sector and capital market
Extensions of GEM-E3 :
- Improvement of the formulation of labour markets.
- Inclusion of multiple household classes.
- Improvement of capital market and capital mobility.

32. Capital and labour formulation of standard GEM-E3
Labour supply is derived from consumption-leisure-savings choice, labour demand depends on the KLEM optimisation
Capital demand is derived from investment function, capital supply depends on general equilibrium closure (Walras law)
Current modelling options for labour market:
Wages determined from equilibrium of supply-demand
Current modelling options for capital market:
Rate of return on capital derived from national budget equilibrium, a reduced form reflecting differentiated interest rates and risk premia
Rate of return on capital derived from multinational income-savings closure
March 2007

33. Labour market extension
Categories of households are introduced with different patterns about consumption and savings
Skills of labour are introduced.
Skills are linked with household categories and the mechanism of income distribution
Each market is imperfect, reflecting negotiation power of unions and the influence of unemployment
Labour is imperfectly mobile across countries.
March 2007

34. Capital market extension
Capital flows financing investment are differentiated per origin and destination in the presence of differentiated rates of return and risk premia
Capital is imperfectly mobile across regions and market clearing is imperfectly coordinated
This extension allows to understand the adjustments to the global economy when structural policies, such trade liberalization, environmental sustainability etc. are undertaken.
March 2007