Introduction

The use of welfare measures is now commonplace in many AGE applications. The calculation and decomposition of welfare have become important parts of the analytical tools used to evaluate and/or compare the impact of policies on regions. In dynamic models, in which the importance of capital ownership features significantly, welfare measures are clearly superior to the use of real GDP as a measure of assessing the benefits of a policy. This is because GDP is defined as goods and services produced in the country, rather than as ownership of produced goods and services. However, calculating and decomposing welfare in a dynamic model are much more difficult tasks than in the traditional comparative static models.

The aim of this chapter is to develop a method for decomposing welfare in the GDyn model presented in Chapter 2. In fulfilling this aim, a number of practical problems associated with decomposing welfare in the GDyn model arise. These problems are discussed and a solution is proposed. It involves a comparative static simulation that allows us to decompose the welfare change resulting from a policy shock at any year during the simulation horizon. The method is illustrated using an example.

The Welfare Decomposition

The welfare decomposition used in the GDyn model is based on the welfare decomposition outlined in Hertel and Huff (2001) for the comparative static GTAP model. Hanslow (2000) generalized it, showing that the decomposition can be applied to other models; for example, with multiple households and/or foreign income flows resulting from foreign capital ownership, remittances, or foreign aid.