A general equilibrium model with an asymmetric Armington function: Method and application

Abstract

In the modeling of imports, most CGE models use Armington functions with symmetric responses to increases and decreases in the ratio of prices of imports and domestic products. In this paper, we extend this by permitting asymmetric responses to changes in this price ratio. Specifically, we assume that it is easier to substitute imports for domestic products than vice versa. The rationale is that, in most contexts, the ability of the outside world to supply close substitutes for domestic products is stronger than the ability of domestic producers to supply close substitutes for imports. The paper presents the mathematical structure of an asymmetric Armington treatment and embeds it in a simple static CGE model based on a Mongolian dataset. The model is used to analyze how the impact of two external shocks - an increase in the foreign currency price of an import and the elimination of the current-account deficit - is influenced by whether a symmetric or asymmetric treatment is used for the Armington function; for the latter, the Armington elasticity is lowered if imports are reduced relative to domestic purchases. The application demonstrates that our asymmetric formulation is simple, robust and that, compared to the symmetric case, asymmetry may lead to important differences in the macro and sectoral impacts of import price shocks. Given this, the paper points to the need for econometric research that estimates Armington elasticities without imposing symmetry. If symmetry is rejected, then it would be important to switch to an asymmetric treatment like the one proposed in this paper.