The economics sub-model of IFs draws on two general modeling traditions. The first is the dynamic growth model of classical economics. Within IFs the growth rates of labor force, capital stock, and multifactor productivity largely determine the overall size of production and therefore of the economy. The second tradition is the general equilibrium model of neo-classical economics. IFs imbeds the production function in a six-sector (agriculture, raw materials, energy, manufactures, services, and ICT) equilibrium-seeking module that represents domestic supply, domestic demand, and trade. Further, the goods and services market representation is embedded in a larger social accounting matrix structure that introduces the behavior of household, firm, and government agent classes, including actions that shape inputs to the production function. This chapter describes the core goods and services market module. The following chapters move to the SAM and the more general equilibrium structure.
The growth portion of the goods and services module responds to endogenous labor supply growth (from the demographic model), endogenous capital stock growth (with a variety of influences on the investment level), and a mixture of endogenous and exogenous specification of advance in multifactor productivity (MFP). The endogenous portion of MFP represents a combination of convergence and country-specific elements that together create a conditional convergence formulation.
The equilibrium-seeking portion of the goods and services market module uses increases or decreases in prices (by sector) to balance demand and supply. Inventory stocks in each sector serve as buffers to reconcile demand and supply temporarily. Prices respond to stock levels. The central equilibrium problem that the module must address is maintaining balance between supply and demand in each of the sectors of the model. IFs relies on three principal mechanisms to assure equilibrium in each sector: price-driven changes in domestic demand; price-driven changes in trade; and stock-driven changes in investment by destination (changes in investment patterns could also be price-driven; IFs uses stocks because of its recursive structure, so as to avoid a 2-year time delay in the response of investment).
The economic sub-model makes no attempt through iteration or simultaneous solution to obtain exact equilibrium in any time point. Kornai (1971) and others have, of course, argued that real world economic systems are not in exact equilibrium at any time point, in spite of the convenience of such assumptions for much of economic analysis. Moreover, the SARUM global model (Systems Analysis Research Unit, 1977) and GLOBUS (Hughes, 1987) use buffer systems similar to that of IFs with the model "chasing" equili"brium over time.
Two "physical" or "commodity" sub-models, agriculture and energy, have structures very similar to each other and to the economic sub-model. They have partial equilibrium structures that optionally, and in the normal base case, replace the more simplified sectoral calculations of the goods and services market module.
In both the economic model and the two elaborated sectoral models, IFs relies upon an adjustment function to alter key variables (demand, prices, trade, and investment) in the pursuit of equilibrium. The adjustment function compares the level of some stock type variable (most often either inventory levels or prices) with a desired level, and adjusts the dependent variable. For details review the Adjustment Mechanism.
For help understanding the equations see Equation Notation .