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Forward-Looking Energy Elasticity Parameters for Nested CES Production Function

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  • Lugovoy, Oleg
  • Potashnikov, Vladimir

Abstract

Elasticities of substitution are the key parameters in CGE modeling. However an estimation and validation of the parameters is not straightforward. One ways is to use a historical data. A data on technological shifts between types of fuels and capital and fuels, observed in the past, could be used to calibrate or econometrically estimate the elasticity coefficients. However, historical trends do not describe all the possible investment options which were available. Moreover such estimates will be based on investment decisions made in particular economic condition, available technological/investment options in the time of decision, and under existing policies. Using such parameters for evaluation of future policy options involves undesirable (and unavoidable) assumption that future technological options are equal or similar to those in the past. A variety of new technological options will be disregarded from the analysis. In the paper we develop a methodology to estimate energy elasticity parameters for a nested CES production function involving “Bottom-Up” technological forward looking models. The bottom-up energy modes have an extensive representation of energy sector, they take into account currently available and expected technological options, but consider only part of an economy and lack connectivity with other sectors, f.i. do not provide a demand respond. Therefore their application is usually limited to the energy sector. There are several attempts to connect the top-down (CGE/AGE) and bottom-up models known as “soft” or “hard link”. However both methodologies require significant reduction of the models’ scale or some compromise in connectivity between the models. The methodology proposed in the paper is another way of hybrid modeling where bottom-up model is required to calibrate parameters for a top-down model. It is expected, the energy nest of a CGE model should provide results similar to the bottom-up model.

Suggested Citation

  • Lugovoy, Oleg & Potashnikov, Vladimir, 2013. "Forward-Looking Energy Elasticity Parameters for Nested CES Production Function," Conference papers 332336, Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project.
    • Handle: RePEc:ags:pugtwp:332336
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