1. June 20051 Place of GE analysis in EC4MACS Insights into the economic mechanisms involved in adjusting to a wide spectrum of environmental policies and measures Fewer technological details than sectoral partial equilibrium models GE models simulate responses to environmental policies not only through reduction of energy use and inter-fuel substitution, but also through reductions of overall economic activity and substitution between energy intensive and less energy intensive activities. comprehensive perspective in cost calculation, welfare implications of different policy measures

2. June 20052 GE Cost Calculation (General) In addition to the direct costs of abatement as estimated by GAINS, PRIMES, TREMOVE and CAPRI, GEM- E3 assesses the gains/losses: – from revenue recycling and from changes in terms of trade, both at the national/regional level and at the international level. –impacts of environmental legislation on industrial competitiveness and activity, either in terms of potential dislocation of activities or of new opportunities and markets for technologies. –Potential overlapping of internationally coordinated and domestically undertaken emission control strategies.

3. June 20053 GEM-E3 Identity GEM-E3 is a multi-country computable general equilibrium model built to evaluate the economic impacts of structural policies and mainly the interactions between the economy, the energy system, the environment and the technological progress GEM-E3 is a modelling framework providing the user with many modelling options: a European model, a World model, and a series of different modelling options GEM-E3 runs on GAMS on a PC and uses MS-Excel for the data and the results A non-developer user may run GEM-E3 after a short training, example IPTS of EC/JRC

4. June 20054 GEM-E3 Data Set The European version of GEM-E3 is entirely based on Eurostat statistics: Input-Output tables, National Accounts, Investment Matrix, Consumption Matrix, Bilateral Trade Matrix, Employment and Capital data. Also Energy Balances and emission statistics. A distinguishing feature of GEM-E3 is the details in representing income distribution, taxation, subsidies, social security and other elements affecting the public budget. The European model can simulate constraints related to public budget. The World version of GEM-E3 is using the GTAP-5 and -6 database.

5. June 20055 GEM-E3 behavioural aspects The model adopts a detailed representation for the production function: KLEM with deep nesting, capital vintages, productivity and technical progress with endogenous components, explicit price formation (under Imperfect Competition) The model adopts a detailed representation for the consumption, savings and labour supply behaviour, which are treated simultaneously and optionally by class of consumers. The model distinguishes between durable and non durable goods and their linkages, the income expectations from imperfect labour markets, and uses a nested LES-CES formulation. The model adopts a separate capital investment decision function which has inter-temporal features, differentiates capital investment premium by origin and destination of investment, and uses adaptive expectations to approximate profitability considerations. Trade on a global scale is formulated by assuming imperfect substitution between goods and services by country or region of origin in the presence of economies of scale, a nesting scheme reflecting weak or strong differentiation of commodities by origin, imperfect competition in supply with product varieties and barriers to trade.

6. June 20056 Basic modelling idea In the multi-country model, the goods are differentiated by origin and are imperfect substitutes at the final and intermediate demand levels (Armington) The perception of differentiation by consumers is further reflected through the form of the demand nesting hierarchy The selling price of a good results from the unit cost, an endogenous mark-up (due to imperfect competition) and the eventual barriers to trade when enlarging the marketThe mark-ups reduce when enlarging the market, as a result of more intensive competition, the larger variety of products and the increasing returns to scale (efficient size of company). This further induces growth.

7. June 20057 Supply Technologies Calibration –Minimum Efficient Scale –Cost Gradient (engineering studies) –Number of equivalent equal size firms from Herfindahl index –Calibration of mark-up Entry/exit of firms –Symmetric firms –Number of firms endogenous –To ensure zero profits or non- zero profits (optional) Endogenous mark-ups –Depending on concentration –Depending on average cost

8. June 20058 Demand nesting hierarchy Structural changes such as the EU Internal Market

9. June 20059 Basic modelling idea The core GEM-E3 already covers energy issues and the interactions with the environment –Separate energy supply sectors, energy-intensive industries and equipment goods in several sub-sectors, etc. –KLEM multiple-level nesting and LES nesting with durable goods and their linkages to non durable goods –Linkage to a detailed environmental sub-model –Calibration to energy projections by PRIMES and POLES However, the core model lacks –Engineering-oriented transparency regarding the energy sector (e.g. electricity generation technologies, least cost dispatching, load curve, etc.) –Non-linear (decreasing return to scale) mechanism for the supply of energy resources, such as the depletable fossil fuels, the sites for renewables or nuclear and the potential for energy efficiency improvement at the energy consumption side

10. June 200510 Bottom-up for power generation Short-term: least-cost dispatching of existing power plants under capacity constraints, for different load segments, placed at the bottom of the electricity sector CES nesting Long-term: investment into new power generation plants based on expected demand, unit costs (capital and fuels) and relative risks; logit or reduced Markowitz formulation Explicitly represents a variety of old and new technologies of power generation with possibility for semi-endogenous learning; hence, the model covers technologies such as nuclear, renewables and hydro the choice of which depends on capital rather than on fuel inputs. Energy investment is linked to the demand for equipment goods, technology progress incorporated through the capital vintages Emissions from power generation linked to the environmental sub-model and policy instruments influence power sector decisions (taxes, subsidies, emission trading, green certificates, etc.) Imports and exports of electricity are endogenous Market imperfections at the national level and the multi-national power market can be reflected; many issues related to the EU Internal Electricity Market can be studied.

11. June 200511 Bottom-up for power generation Dispatching under capacity constraints Investment in new power plants Price of electricity – options Mark-up (under IC) Ramsey-Boiteux to recover fixed costs Influenced by Fuel and technology costs Environmental policies

12. June 200512 Depletable energy resources The price of energy resources (e.g. oil, gas) become endogenous at world or regional scales, as a function of –The rate of extraction r from proven reserves and d the rate of discovery of new reserves which are function of d and yet-to-find- reserves –The accumulated use of the resources The reserves are introduced as a separate production factor into the CES of energy producing sectors, separately from capital Reserves, as capital, show a decreasing return to scale pattern, however influenced by technology progress and new discoveries In the presence of climate change policies, abatement costs increase as a result of lower fossil fuel prices related to lower demand; opposite effects in case of dash for gas.

13. June 200513 Endogenous energy savings The decision to invest in energy saving equipment becomes endogenous Production and consumption functions are extended with the energy saving considered as an additional factor Energy saving draws from a limited potential for savings per sector, hence follows decreasing return to scale Investment in energy saving induces expenses taken into account in the least cost decision of the agent; their unit cost increases as potential is exhausted The purchase of goods to implement energy saving influences total demand for goods and services Interesting results from a study on “Energy savings and employment effects in the EU”

14. June 200514 Illustrations Energy saving investment induced by energy price increase Price of the resource Time PbPb P0P0 Price path with no discoveries New Discoveries Evolution of prices of depletable resources when new discoveries take place

15. June 200515 Studying combined objectives Policy Agenda 1.The Knowledge Society 2.The Internal Market 3.The Business Climate 4.The Labour Market 5.Environmental Sustainability The model extensions 1.Endogenous Technical Progress 2.Market Integration under imperfect competition and product varieties 3.Capital market and investment flows 4.Labour market under imperfect competition 5.Energy-Environment sustainability driving innovation, demand for equipment goods and exports

16. June 200516 Energy-environment driving growth?  EU is comparatively strong in Equipment Goods Industry and the Services sector  EU internal market area is sufficiently large so as the market integration to sustain competition, scale effects and technology progress  A stringent policy in terms of energy-environment can drive accelerated technical progress and investment in the Equipment Industry and Services, resulting into economies of scale, hence in comparative advantage at world level  The EU-internal demand sustains employment and activity  In the long run, the new exporting potential drives additional accelerated growth of the EU area  Such a strategy, with removal of uncertainties related to capital and investment, may push the EU to enter into a new investment cycle..