Production, Input Demand and Factor Markets
Production relationships by activities are characterized by nested Constant Elasticity of
Substitution (CES) production functions. Activity output is a CES composite of aggregate
intermediate inputs and aggregate value added, while aggregate intermediate inputs are a
Leontief aggregate of the individual intermediate commodity inputs and aggregate value
added is a CES composite of primary factors demanded by each activity. The
determination of product supply and input demand is based on the assumption of profit
maximizing behaviour.
Factor markets in developed countries are characterized by inelastic factor supplies and
the model solves for market-clearing factor prices. In developing regions, however, we
assume that the real wage of skilled and unskilled labour is fixed in terms of the domestic
consumer price index and that the supply of skilled and unskilled labour is infinitely
elastic at that wage. In this specification, any shock that would otherwise reduce the
equilibrium wage will instead lead to increased unemployment.
While skilled and unskilled labour is mobile across activities, land and natural resources
are activity-specific under the activity aggregation used in the present study. Given the
short-run perspective of the present study, physical capital is likewise treated as sectorspecific
in the simulations reported below.
Final Domestic Demand by Commodity
The commodity composition of government consumption demand and investment
demand is fixed, with demand patterns from the benchmark data set. Households are
utility maximizers who respond to changes in relative prices and incomes. In this version
of the model, the utility functions for private households take the Stone-Geary form and
hence consumer demand by commodity is described by a Linear Expenditure System
(LES) specification.
Macro Closure
For this exercise a neutral or balanced set of macro closure rules is specified. Current
account balances for all regions are assumed to be fixed at initial benchmark levels in
terms of the global numeraire and real exchange rates adjust to maintain external