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Total domestic demand consists of the demand of products by the consumers, the producers (for intermediate consumption and investment) and the public sector. This is allocated between domestic products and imported products, according to the Armington specification. Each country buys and imports at the prices set by the supplying countries following their export supply behaviour


Figure 2.2: Trade matrix for EU and the rest of the world
The GEM-E3 model endogenously computes energy consumption, depending on energy prices, realised energy efficiency expenditures and autonomous energy efficiency improvements. Each agent decides how much energy it will consume in order to optimise its behaviour (i.e. to maximise profits for firms and utility for households) subject to technological constraints (i.e. a production function).


[[Image:GEM-E3IMPORT/attachments/34379186/35291142.gif|35291142.gif]]
At a sectoral level, energy consumption is derived from profit maximization under a nested CES (Constant Elasticity of Substitution) specification. Energy enters the production function together with other production factors (capital, labour, materials). Substitution of energy and the rest of the production factors is imperfect (energy is considered an essential input to the production process) and it is induced by changes in the relative prices of each input.


GEM-E3 employs a nested commodity aggregation hierarchy, in which branch?s i total demand is modelled as demand for a composite good or quantity index Yi which is defined over demand for the domestically produced variant and the aggregate import good. At a next level, demand for imports is allocated across imported goods by country of origin. Bilateral trade flows are thus treated endogenously in GEM-E3.
Residential energy consumption is derived from the utility maximization problem of households. Households allocate their income between different consumption categories and savings to maximize their utility subject to their budget constraint. Consumption is split between durable (i.e. vehicles, electric appliances) and non-durable goods. For durable goods, stock accumulation depends on new purchases and scrapping. Durable goods consume (non-durable) goods and services, including energy products. The latter are endogenously determined depending on the stock of durable goods and on relative energy prices.


Figure 2.3: Domestic demand and trade flows nesting scheme


[[Image:GEM-E3IMPORT/attachments/34379186/35291143.gif|35291143.gif]]
'''Energy efficiency'''


The minimum unit cost of the composite good determines its selling price. This is formulated through a CET unit cost function, involving the selling price of the domestic good, which is determined by goods market equilibrium, and the price of imported goods, which is taken from the 2nd level Armington. By applying Shephard?s lemma, total demand for domestically produced goods and for imported goods is derived.
Energy efficiency in the GEM-E3 model can result from three factors:


Export of services from country cr to country cs will be equal to the bilateral import of services of country cs from cr. The model ensures analytically that, the balance of trade matrix in value and the global Walras law is verified in all cases. A trade flow from one country to another country matches, by construction, the inverse flow. The model ensures this symmetry in volume, value and deflator. Thus the model guarantees (in any scenario run) all balance conditions applied to the world trade matrix, as well as the Walras law at the level of the planet.
• An increase in the amount agents spend to improve energy intensity in response to regulations, for example, by mirroring energy saving obligations or a minimum performance of energy efficiency (endogenous mechanism based on cost-potential curves for energy efficiency by sector).


Household demand is determined by the decision to allocate income between current and future consumption (this decision derives from the utility maximization subject to an inter-temporal budget constraint which states that all available disposable income will be spend at the present or at some time in the future) and by the allocation of current expenditure among different consumption categories.  Consumption categories include non-durable consumption categories (food, culture etc.) and services from durable goods (cars, heating systems and electric appliances). Based on myopic assumptions about the future, the household decides the amount of leisure that wishes to forsake in order to acquire the desired amount of income (thus also defining labour supply behaviour).
• A change in energy prices that triggers the substitution of relatively less expensive inputs for more expensive energy, along the frontiers of substitution possibility.


At the second stage, total household consumption is disaggregated into demand for specific consumption goods. For this the integrated model of consumer demand for non-durables and durables, developed by Conrad and Schröder (1991) is implemented. Households obtain utility from consuming a non-durable good or service and from using a durable good. The consumer decide on the desired stock of the durable based not on its relative purchase cost and on the cost of goods linked with that durable.
• A change in the rate of energy-embodied technological progress (based on exogenous projections that reflect technological progress).


With regards to the firms, in GEM-E3 production technologies are formulated in an endogenous manner allowing for price-driven demand for intermediate goods. Factor demand is derived from Shephard?s lemma. In this process it is assumed that the stocks of capital and labour are proportional to the optimal flows in volume. At each level of the nesting scheme of the production function, demand for a factor at a lower level of the nesting scheme is linked to bundle to which it belongs, with different substitution elasticities at each level. This gives finally a cost-minimising demand for each production factor.
Expenditures in energy saving technology are treated as spending that economic agents undertake so as to reduce their energy consumption (e.g. purchases of more energy efficient appliances, insulation of buildings and retrofit etc.). For firms, expenditures in energy saving impact on their energy intensity and do not add to their capital stock (as opposed to investments). As energy saving expenditures do not add to the capital stock of firms, the productive capacity of the firms remains unchanged (i.e. energy saving expenditures of a firm reduce energy consumption per unit produced but they do not affect its productive capacity, that is the number of units that a factory can produce). Energy efficiency expenditures reduce energy consumption one period after they take place and continuously for a period of at least 20 years. Households’ expenditures in energy efficiency improvements do not have a direct impact on their utility. The impact is indirect through the reduced energy costs that households have to pay.
==Behavioural change==
GEM-E3 model combines micro and macro analysis. At micro level the model contains a detailed representation of economic agents? (firms, households, public sector) behavior. The model formulates the supply and demand behaviour of the economic agents regarding production, consumption, investment, employment and allocation of their financial assets. The demand of products by the consumers, the producers (for intermediate consumption and investment) and the public sector constitutes the total domestic demand. This total demand is allocated between domestic products and imported products, following the Armington specification. In this specification, branches and sectors use a composite commodity which combines domestically produced and imported goods, which are considered as imperfect substitutes (Armington assumption). Each country buys and imports at the prices set by the supplying countries following their export supply behaviour. The buyer of the composite good (domestic) seeks to minimise his total cost and decides the mix of imported and domestic products so that the marginal rate of substitution equals the ratio of domestic to imported product prices.


In the GEM-E3 model prices are the result of market equilibrium (demand and supply effects). On derived prices appropriate taxation is applied, to form prices as perceived by consumers. The main leading price is that of the composite good. Depending on the destination of a commodity, differentiated taxation may be applied, as for example indirect taxation or VAT.
Expenditures in energy efficiency improvements generate additional demand for goods and services (ferrous and non-ferrous metals, non-metallic goods, chemical products, electrical goods, construction and market services) which provide inputs to energy efficiency projects (see Table 10).


'''Households' behavior'''
Energy efficiency improvements exhibit decreasing marginal returns (saturation effect). Energy savings potential is inter-temporally limited (differently by sector) and higher energy saving entails an increase in marginal costs.


Households in the GEM-E3 SAM are identified as a single social group (a single representative household is modeled). Households maximize their inter-temporal utility under an inter-temporal budget constraint. The demand functions are derived by solving the maximization problem, under general assumptions regarding expectations and steady state conditions. These demand functions allocate the expected income of the household, depending on the formulation of the problem, between consumption goods and future consumption (savings). This is the default formulation of households? behaviour. Alternatively household behavior is modeled so that the consumer allocates its expected income between present, future consumption and leisure. Households receive income from their ownership of production factors, from other institutions and transfers from the rest of the world. Household expenditure is allocated between consumption, tax payment and savings.


The representative household firstly decides on the allocation of its income between present and future consumption of goods. At a 2nd stage the household allocates its total consumption expenditure between the different consumption categories available. The consumption categories are split in non-durable consumption categories (food, culture etc.) and services from durable goods (cars, heating systems and electric appliances). For this allocation an integrated model of consumer demand for non-durables and durables, developed by Conrad and Schröder (1991) is implemented. The rationale behind the distinction between durables and non-durables is that the households obtain utility from consuming a non-durable good or service and from using a durable good. So for the latter the consumer has to decide on the desired stock of the durable based not only on the relative purchase cost of the durable, but also on the cost of those goods that are needed in connection with the durable (as for example fuels for cars or for heating systems). The general form that is described above is being depicted with a nesting scheme as it is appeared below.
'''Calculating levels of energy efficiency expenditure'''


Figure 2.5: The consumption structure of the GEM-E3 model<br />[[Image:GEM-E3IMPORT/attachments/34379189/34702000.jpg|34702000.jpg]]<br />
Expenditures in energy efficiency imply the accumulation of energy saving stock that is more energy efficient than the benchmark. Thus, specific rates of energy consumption (of equipment) and energy requirements are reduced, which contributes to savings of energy consumption following their installation. The higher upfront expenditures for energy efficiency imply funding requirements that need to be drawn from savings and from other borrowing. The additional funds are drawn from the entire economy (the sum of the economic agents’ savings and general financing from financial institutions), eventually stressing capital supply in the economy. Energy efficiency expenditures have no direct impact on the capital stock as they are used by the agents to purchase goods and services that reduce energy consumption and are not used to increase directly productive capacity. The sectors that provide the energy saving goods and services need to increase their productive capacity in order to meet the increased demand for their products and to this end compete for capital resources with all the other sectors in the economy. This leads to a crowding out effect, the magnitude of which depends on the assumptions about capital market flexibility worldwide and financial resources overall. Spending on energy efficiency stimulates demand for sectors that produce the required goods and services, such as construction, industrial materials, equipment and certain market services. The modelling takes into account that the demand for, and expenditure on, energy decreases permanently in the periods that follow energy efficiency expenditures. For the modelling of the energy saving expenditures the basic assumption is that institutional authorities at national, EU or World level define, by sector, obligations that target pre-specified rates of energy efficiency improvements. The amount of energy efficiency expenditure that is required to reach the pre-specified rate of reductions of energy intensity  is determined by the energy efficiency cost curves.


'''Firms' behavior'''
Energy efficiency projects generate demand for inputs from several sectors. Technical coefficients are used to determine the share that each sector delivering inputs to the energy efficiency projects has on the final expenditure made, i.e. for every expenditure made on energy efficiency projects what percentage of it is spend on each of the different sectors providing inputs to energy efficiency projects. Table 10 shows which sectors contribute to the realisation of the energy savings projects and at what shares. These sectors then generate demand for the output of all other sectors through Leontief’s Input-Output system, based on technical coefficients that are endogenously projected by the model.


In the GEM-E3 model firms are modeled to maximize their profits, constrained by the physical capital stock (fixed within the current period) and the available technology. Producers can change their physical capital stock over time through investment. Capital stock data by sector of production are not available either from GTAP or from EUROSTAT databases (it is computed in the calibration phase of the model).


Each producer (represented by an activity) is assumed to maximize profits, defined as the difference between the revenue earned and the cost of factors and intermediate inputs. Profits are maximized subject to its production technology. Domestic production is defined by branch. It is assumed that each branch produces a single good which is differentiated from any other good in the economy.
Table 10: Sectoral breakdown of expenditures on energy efficiency projects


Production functions in GEM-E3 exhibit a nested separability scheme, involving capital, skilled and unskilled labour, energy and materials and are based on a CES neo-classical type of production function. The exact nesting scheme of production in GEM-E3 has been selected to match available econometric data on KLEM substitution elasticities and the specific features of each activity. The optimal production behaviour can be represented in the primal or the dual formulation. Their equivalence, under certain assumptions, can be verified by the theory of production behaviour.
{| class="wikitable"
 
|width="30%" |'''Sector'''
In the model the dual formulation is used and the long run unit cost function is of the nested CES type with factor-augmenting technical change, i.e. price diminishing technical change. The firm (at branch level) decides its supply of goods or services given its selling price and the prices of production factors.
|width="70%" |'''Share of expenditure (in equipment goods and services used to implement energy efficiency investment) as received by production sector, in % of overall expenditure in energy efficiency'''
 
|-
The production technology exhibits constant return of scale. The firm supplies its good and selects a production technology so as to maximize its profit within the current year, given the fact that the firm cannot change the stock of productive capital within this period of time. The firm can change its stock of capital the following year, by investing in the current one. Since the stock of capital is fixed within the current year, the supply curve of domestic goods is upwards sloping and exhibits decreasing return to scale.
|Ferrous metals
 
|4
Non-energy sectors: At the 1st level, production is split into two aggregates, one consisting of capital, labour, energy bundle (KLE) and the other consisting of materials (MA). At the 2nd level, (KLE) is split in two aggregates, one consisting of capital and labour bundle (KL), and the other consisting of energy (ENG). (MA) is further divided in its component parts (e.g. Agriculture, Industrial activities, Services etc.). At the 3rd level (KL) is split into capital and skilled labour bundle (KL_skld), which is further decomposed at the 4th level between Capital and skilled Labour and unskilled labour (_L_unskld_), whereas (ENG) is split in electricity and fuels (EN).
|-
 
|Non-ferrous metals
Figure 2.6:  Production nesting scheme in the GEM-E3 model ? Non energy sectors
|4
 
|-
[[Image:GEM-E3IMPORT/attachments/34379189/35291154.gif|35291154.gif]]<br />
|Chemical Products
 
|7
''Resource sectors'': For the sectors whose production is based on natural resources, at the 1st nesting level production is split between fossil fuel resources (RES) and an aggregate bundle consisting of capital, labour and material-energy (KLEMrs). The latter at the 2nd stage is disaggregated in the material-energy bundle (MAENrs) and the capital-labour bundle (KL). At the 3rd level the capital-labour bundle (KL) is split in capital and skilled labour (KL_skld) and in unskilled labour. The material-energy bundle (MAENrs) is divided into its component parts. Finally capital-skilled labour bundle is spit into capital and skilled labour.
|-
 
|Non-metallic minerals
Figure 2.7: Production nesting scheme in the GEM-E3 model ? Resource sectors
|8
 
|-
[[Image:GEM-E3IMPORT/attachments/34379189/35291155.gif|35291155.gif]]<br />''Power supply sectors'': At the 1st nesting level of the power supply sector, production is split into two aggregates, one consisting of a bundle of power producing technologies (TECH) and the other of the transmission and distribution part (DIST). At the 2nd level, all power producing technologies identified in the model are in the same nest whereas the (DIST) bundle is disaggregated to capital, skilled and unskilled labour and materials.
|Electric Goods
 
|2
Figure 2.8:  Production nesting scheme in the GEM-E3 model ? Electricity supply
|-
 
|Construction
[[Image:GEM-E3IMPORT/attachments/34379189/35291237.gif|35291237.gif]]
|60
 
|-
''Power producing technologies'': one level production function that includes capital, skilled and unskilled labour and fuels is assumed.<br />
|Market Services
 
|15
Figure 2.9:  Production nesting scheme in the GEM-E3 model ? Power producing technologies
|-
 
|}
[[Image:GEM-E3IMPORT/attachments/34379189/35291238.gif|35291238.gif]]<br /> 
 
Refineries: the nesting structure is similar to the non-energy sectors with a change in the top level of the nest where the two aggregates are now (KLEM) and fuels (FUEL).<br /><br />
 
Figure 2.10:  Production nesting scheme in the GEM-E3 model ? Refineries [[Image:GEM-E3IMPORT/attachments/34379189/35291239.gif|35291239.gif]]<br /> Firms address their products to three market segments namely to the domestic market, to the other EU countries and to the rest of the world. Prices are derived through demand/supply interactions. In any iteration of the model run and before global equilibrium is achieved, producers face demand for their products. To this demand they respond with a price. For the PC sectors, since these operate under constant returns to scale and the number of firms is very large, this price depends only on their marginal cost of production.
 
The producer is assumed not to differentiate his price according to the market to which he sells his products. He therefore sells his products at the same price (equal to his marginal cost reduced by the amount of production subsidies that he receives).
 
'''Government behavior'''
 
The Governments? behaviour is exogenous in GEM-E3. Government?s final demand by product is obtained by applying fixed coefficients to the exogenous volume of government consumption.

Latest revision as of 15:43, 21 October 2016

Model Documentation - GEM-E3

Corresponding documentation
Previous versions
Model information
Model link
Institution Institute of Communication And Computer Systems (ICCS), Greece, https://www.iccs.gr/en/.
Solution concept General equilibrium (closed economy)
Solution method Optimization
Anticipation

The GEM-E3 model endogenously computes energy consumption, depending on energy prices, realised energy efficiency expenditures and autonomous energy efficiency improvements. Each agent decides how much energy it will consume in order to optimise its behaviour (i.e. to maximise profits for firms and utility for households) subject to technological constraints (i.e. a production function).

At a sectoral level, energy consumption is derived from profit maximization under a nested CES (Constant Elasticity of Substitution) specification. Energy enters the production function together with other production factors (capital, labour, materials). Substitution of energy and the rest of the production factors is imperfect (energy is considered an essential input to the production process) and it is induced by changes in the relative prices of each input.

Residential energy consumption is derived from the utility maximization problem of households. Households allocate their income between different consumption categories and savings to maximize their utility subject to their budget constraint. Consumption is split between durable (i.e. vehicles, electric appliances) and non-durable goods. For durable goods, stock accumulation depends on new purchases and scrapping. Durable goods consume (non-durable) goods and services, including energy products. The latter are endogenously determined depending on the stock of durable goods and on relative energy prices.


Energy efficiency

Energy efficiency in the GEM-E3 model can result from three factors:

• An increase in the amount agents spend to improve energy intensity in response to regulations, for example, by mirroring energy saving obligations or a minimum performance of energy efficiency (endogenous mechanism based on cost-potential curves for energy efficiency by sector).

• A change in energy prices that triggers the substitution of relatively less expensive inputs for more expensive energy, along the frontiers of substitution possibility.

• A change in the rate of energy-embodied technological progress (based on exogenous projections that reflect technological progress).

Expenditures in energy saving technology are treated as spending that economic agents undertake so as to reduce their energy consumption (e.g. purchases of more energy efficient appliances, insulation of buildings and retrofit etc.). For firms, expenditures in energy saving impact on their energy intensity and do not add to their capital stock (as opposed to investments). As energy saving expenditures do not add to the capital stock of firms, the productive capacity of the firms remains unchanged (i.e. energy saving expenditures of a firm reduce energy consumption per unit produced but they do not affect its productive capacity, that is the number of units that a factory can produce). Energy efficiency expenditures reduce energy consumption one period after they take place and continuously for a period of at least 20 years. Households’ expenditures in energy efficiency improvements do not have a direct impact on their utility. The impact is indirect through the reduced energy costs that households have to pay.

Expenditures in energy efficiency improvements generate additional demand for goods and services (ferrous and non-ferrous metals, non-metallic goods, chemical products, electrical goods, construction and market services) which provide inputs to energy efficiency projects (see Table 10).

Energy efficiency improvements exhibit decreasing marginal returns (saturation effect). Energy savings potential is inter-temporally limited (differently by sector) and higher energy saving entails an increase in marginal costs.


Calculating levels of energy efficiency expenditure

Expenditures in energy efficiency imply the accumulation of energy saving stock that is more energy efficient than the benchmark. Thus, specific rates of energy consumption (of equipment) and energy requirements are reduced, which contributes to savings of energy consumption following their installation. The higher upfront expenditures for energy efficiency imply funding requirements that need to be drawn from savings and from other borrowing. The additional funds are drawn from the entire economy (the sum of the economic agents’ savings and general financing from financial institutions), eventually stressing capital supply in the economy. Energy efficiency expenditures have no direct impact on the capital stock as they are used by the agents to purchase goods and services that reduce energy consumption and are not used to increase directly productive capacity. The sectors that provide the energy saving goods and services need to increase their productive capacity in order to meet the increased demand for their products and to this end compete for capital resources with all the other sectors in the economy. This leads to a crowding out effect, the magnitude of which depends on the assumptions about capital market flexibility worldwide and financial resources overall. Spending on energy efficiency stimulates demand for sectors that produce the required goods and services, such as construction, industrial materials, equipment and certain market services. The modelling takes into account that the demand for, and expenditure on, energy decreases permanently in the periods that follow energy efficiency expenditures. For the modelling of the energy saving expenditures the basic assumption is that institutional authorities at national, EU or World level define, by sector, obligations that target pre-specified rates of energy efficiency improvements. The amount of energy efficiency expenditure that is required to reach the pre-specified rate of reductions of energy intensity is determined by the energy efficiency cost curves.

Energy efficiency projects generate demand for inputs from several sectors. Technical coefficients are used to determine the share that each sector delivering inputs to the energy efficiency projects has on the final expenditure made, i.e. for every expenditure made on energy efficiency projects what percentage of it is spend on each of the different sectors providing inputs to energy efficiency projects. Table 10 shows which sectors contribute to the realisation of the energy savings projects and at what shares. These sectors then generate demand for the output of all other sectors through Leontief’s Input-Output system, based on technical coefficients that are endogenously projected by the model.


Table 10: Sectoral breakdown of expenditures on energy efficiency projects

Sector Share of expenditure (in equipment goods and services used to implement energy efficiency investment) as received by production sector, in % of overall expenditure in energy efficiency
Ferrous metals 4
Non-ferrous metals 4
Chemical Products 7
Non-metallic minerals 8
Electric Goods 2
Construction 60
Market Services 15
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