Glossary of Terms

Armington assumption: Allows domestically produced and foreign produced goods to be imperfect substitutes in use, making the consumption of quantities of domestically produced and imported variants of the commodity to enter the representative consumer’s utility function as distinct elements. In empirical CGE formulations, this assumption helps to overcome the "specialization" problem (de Melo and Tarr).

Calibration: The process by which values of the normalizing (or free) parameters are determined so as to replicate the observed flow values incorporated in the social accounting matrix (SAM), assuming all the equations describing the equilibrium in the system (model) are met in the benchmark period. This process is augmented by literature search (and on occasion econometric estimation) for key model parameters, whose values are required before the calibration can proceed. In practice, due to the wide spread use of CES functions in applied models, "key" parameters are more or less synonymous with elasticities (Mansur and Whalley).

Cobb-Douglas production function: A production function in which the elasticity of factor substitution is constant and equal to unity. In general, this function has the form , where A is an efficiency parameter, x and y are the inputs and a and b are their coefficients (which, for this function, are equal to elasticities).

Compensating variation: An estimate in money terms of the amount households would require as compensation in order to remain as well off after an exogenous shock as they were before the shock. This welfare measure is based on new equilibrium prices.

Computable General Equilibrium (CGE) model: An integrated system of equations (or general equilibrium model), derived from economic theory of the behavior of all economic agents, whose simultaneous solution uses a numerical database to determine values of the endogenous variables. By simulating the effects of policy, structural or market changes, a well-defined CGE model is a useful tool for economic impact analysis.

Duality: Duality in neoclassical microeconomics refers to the existence, under appropriate regularity conditions, of indirect (or dual) functions which embody the same essential information on preferences or technology as the more familiar direct (or primal) functions such as production and utility functions. Dual functions contain information about both optimal behavior and structure of the underlying technology or preferences, whereas the primal functions describe only the latter. Many relationships that are difficult to understand when looked at directly become simple, or even trivial, when looked at using the tools of duality (Varian).

Equivalent variation: Defined the same as compensating variation except that this welfare measure is based on initial equilibrium prices rather than new equilibrium prices.

ES202: A federal-state program summarizing employment, wage and contribution data from employers subject to state unemployment laws, as well as workers covered by unemployment compensation for federal employees (UCFE). The ES202 program is also called Covered Employment and Payrolls (CEP) program and involves the Bureau of Labor Statistics (BLS) of the U.S. Department of Labor and the State Employment Security Agencies (SESAs).

Externality: Side effects of an action that influence the well-being of nonconsenting parties. The nonconsenting parties may be either helped (by external benefits) or harmed (by external costs). For example, the effect of an industry’s output on the total costs of each firm and/or other participants in the economy.

Frisch parameter: Marginal utility of income with respect to income (de Melo and Tarr).

General equilibrium model: A model of an economy that portrays the operation of many markets simultaneously.

Hicksian demands: Demand functions that are derived from cost minimization, commonly referred to as the dual problem in demand analysis. These functions tell us how quantity is affected by prices with utility held constant. Primal to these demands are the Marshallian demands, which are derived from maximizing utility holding income constant.

Imperfect competition: Any market structure in which firms do not exhibit the characteristics of perfect competition.

Lagrangian: A mathematical technique used to find values of variables that minimize or maximize an objective function while satisfying equality constraints.

Law of one price: The assumption that the price of a commodity differs between any two levels of the marketing channel by no more than the transfer costs. For example, by this law, the price is expected to differ between any two locations by no more than transportation costs. Implicit in this law is the assumption of extreme specialization and perfect substitution between domestic and foreign commodities.

Leontief production function: (see Leontief technology below)

Leontief technology: A production technology in which inputs always enter in fixed proportions to produce a unit of output (zero elasticity of factor substitution). Thus, the input that poses a binding constraint determines the amount of output to be produced. Mathematically, Leontief technology is presented as: , where x and y are the inputs and a and b are their fixed coefficients.

Market distortion: Market failure that is caused by deliberate policy intervention, such as imposition of a tax or a subsidy. [see definition of market failure below]

Market failure: Failure of the market system to attain hypothetically ideal allocative efficiency. This means that potential gain exists that (for some reason) has not been captured.

Missing markets: Absence or incompleteness of markets for some goods and services, which renders prices for such commodities nonexistent. For example, an agent (e.g. firm) may care about an externality (e.g. pollution) generated by another agent but have no way to influence it.

Monopoly: A market structure characterized by a single seller of a well-defined commodity for which there are no good substitutes and by high barriers to the entry of other firms into the market for that commodity.

Monotonically decreasing: A function g(× ) is said to be monotonically decreasing if, for any x > y, g(x) < g(y).

Monotonically increasing: A function g(× ) is said to be monotonically increasing if, for any x > y, g(x) > g(y).

Non-convexity: Non-convexity is explained by the incapacity of the additivity and divisibility hypotheses on production to hold. The additivity assumption says that if two production plans are technologically feasible, a new production plan consisting of the sum of these two will also be possible. Divisibility, on the other hand, states that if a production plan is feasible, then any production plan consisting of a reduction in scale will also be feasible. Failure of the divisibility assumption is argued as the main source of non-convexities in production.

Oligopoly: A market structure in which there are only a few sellers of a commodity (competition among the few).

Partial equilibrium model: A model of a single market that ignores repercussions in other markets.

Perfect competition: A widely used economic model (market structure), where it is assumed that there is a large number of buyers and sellers for any commodity and each agent is a price taker.

Returns to scale: The term returns to scale refers to the response of output when proportional increases in all inputs are carried out (scale of operation). If output increases by a smaller proportion, then the technology is said to exhibit decreasing returns to scale (diseconomies), but if it increases by a greater proportion than the inputs it exhibits increasing returns to scale (economies). If output increases by the same proportion as the inputs, we refer to this technology as constant returns to scale. Mathematically, if , k>1 implies increasing returns, k<1 decreasing returns, and k=1 constant returns when X is a vector of inputs, is the production technology, and m is a scalar.

Specialization problem: The Law of One Price implies extreme specialization in an economy where goods are produced under CRS and the number of commodities exceeds the number of factors of production.

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