Pratt, Stephen and Blake, Adam and Swann, Peter
(2013)
Dynamic general equilibrium model with uncertainty: Uncertainty regarding the future path of the economy.
Economic Modelling, 32
.
429 - 439.
ISSN 0264-9993
Abstract
This paper develops a new method for incorporating uncertainty within a computable general equilibrium
(CGE) model. The method involves incorporating uncertainty into the model by formulating different states
of the world or paths that the economy may take. The risk then is that on one or more of the paths, there may
be an external demand shock, for example, an exogenous shock in tourism demand. The multi-sector
forward-looking CGE model with risk shows the impact of uncertainty on the economy and how households
and industry respond to the presence of uncertainty. The results show that, where there is an asymmetric
shock, the possibility of a future tourism demand shock creates a welfare loss. The welfare gains along the
non-shocked path are a result of household's risk aversion and their substituting resources away from the
shocked path. The difference in the monetary values of the welfare on the different paths can be interpreted
as the ‘price’ of the risk. It is the price households would pay to remove the possibility of the tourism shock.
Therefore, this research was able to quantify the monetary value of the risk. This method can be used in
scenario modelling for other adverse contingent events, such as the uncertainty of climate change impacts,
and agriculture production risks.
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