A computable general equilibrium (CGE) model is a system of mathematical equations that describes an economy as a whole, and the interactions among its parts. A model this comprehensive is more complex than the bicycle industry model that we built in Chapter 1, but it need not be a “black box.” In this chapter, we deconstruct the CGE model and describe its core elements. We show that a CGE model and the simple bicycle model share many features, such as exogenous and endogenous variables, market-clearing constraints, and identity and behavioral equations. We describe how the price of a single commodity changes as the product moves along the supply chain from producers to consumers. We explain the practice of normalizing prices and the role of the price numeraire. We introduce model closure, which is the decision about which variables are exogenous and which are endogenous. We also describe how the CGE model runs by explaining the sequence of model calibration, model solution, and model experiment.

In this chapter, our objective is to introduce, at a general level, the model's elements and mechanics.