On the need to compensate the compensating variation in CGE modeling

Ana Isabel Guerra, Ferran Sancho

Research output: Contribution to journalArticleResearchpeer-review

2 Citations (Scopus)

Abstract

© 2017, © 2017 The International Input–Output Association. The message of this research is that in the standard calibrated setting of Computational General Equilibrium (CGE) models, the welfare measures typically used to compare benchmark with counterfactuals are numéraire dependent. This evaluation bias affects the compensating variation and the Konüs index of cost of living. We show that the equivalent variation is neutral regarding the choice of value units in calibrated models but would be affected as well in uncalibrated CGE models. We illustrate with a simple example and propose an even simpler theoretical solution to overcome these biases; all that is required to have correct welfare estimates is to compensate normalizing with a suitable price index. This type of correction is necessary to overcome the sometimes blind implementation of welfare measures in numerical general equilibrium analysis. We show that the induced quantitative errors may be substantial providing biased welfare estimates and misleading results.
Original languageEnglish
Pages (from-to)313-322
JournalEconomic Systems Research
Volume30
Issue number3
DOIs
Publication statusPublished - 3 Jul 2018

Keywords

  • Compensating variation
  • computable general equilibrium
  • equivalent variation

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