Computable General equilibrium Models in Environmental and Resource Economics

The focus of this survey chapter is on the importance of general equilibrium interactions in assessing efficiency costs of environmental policies. Those interactions are relevant to the impacts of a wide range of government policies to control air pollution, deforestation or water quality. These policies raise the costs of output and the distortions in factor markets from preexisting market imperfections and imply higher social costs than would be indicated by partial equilibrium models. Although computable general equilibrium models (CGE models) cannot be used to forecast business cycles, they can indicate likely magnitudes of policy-induced changes from future baselines, and they are indispensable for ranking alternative policy measures. Since these numerical models are based on assumptions concerning the economic development (elasticities of substitution, technical change, or the magnitude of exogenous variables) it would be misleading to base policy decisions on a specific numerical result. Rather, CGE models should be used to understand the reasons for particular results, to better frame the policy decisions, and to support the appropriate policy judgements. Using general equilibrium theory, economists can very often get a good idea of the welfare effect and of the qualitative results from a change in a given policy instrument.