Aggregate demand by sector is summed across all domestic agents and represents a composite of domestically produced goods and imports—the so-called Armington aggregate.<sup>24</sup> The aggregate Armington good is allocated between domestic production and imports using a two-nested CES specification. The first nest allocates aggregate demand between domestic production and an aggregate import bundle. The second nest decomposes aggregate imports into import by region of origin. This generates a bilateral trade flow matrix. Domestic producers are assumed to supply both domestic and export markets without friction, i.e. the law of one price holds for domestically produced goods irrespective of their final destination.<sup>25</sup> Bilateral trade is associated with three price wedges. The first wedge reflects differences between producer prices and the border (FOB) price, i.e. an export tax or subsidy. The second wedge reflects international trade and transport margins, i.e. the difference between FOB and CIF prices. The third wedge reflects the difference between the CIF price and the end-user price, i.e. import tariffs. All three wedges are fully bilateral.

Model closure is consistent with long-term equilibrium. As stated above, fiscal balance is maintained through lump sum taxes on households under the assumption of fixed public expenditures (relative to GDP). Changes in revenues, for example carbon tax revenues, imply a net decrease in household direct taxes. Investment is savings driven. This assumption implies that changes in investment are likely to be relatively minor since public and foreign savings are fixed and household savings will be relatively stable relative to income. The third closure rule is that the capital account is balanced. Ex ante changes in the trade balance are therefore offset through real exchange rate effects. A positive rise in net transfers, for example through a cap and trade scheme, would tend to lead to a real exchange rate appreciation.

The model dynamics are relatively straightforward. Population and labor force growth rates are based on the UN population’s projection<sup>26</sup> —with the growth in the labor force equated to the growth of the working age population. Investment, as mentioned above, is savings driven and the latter is partially influenced by demographics. Productivity growth in the baseline is ‘calibrated’ to achieve a target growth path for per capita incomes— differentiated for agriculture, manufacturing and services.

Emissions of GHGs have three drivers. Most are generated through consumption of goods—either in intermediate of final demand—for example the combustion of fossil fuels. Some are driven by the level of factor input—for example methane produced by rice is linked to the amount of cultivated land. And the remainder is generated by aggregate output—for example waste-based methane emissions. The climate module takes as inputs emissions of GHGs and converts them to atmospheric concentration, then radiative forcing and finally temperature change.<sup>27</sup>

> 24 Armington 1969.

> 25 Analogously to aggregate domestic demand, the model allows for a two-nested constant-elasticity-oftransformation function to allocate domestic production between domestic and foreign markets. 26 United Nations 2007.

> 27 The climate module is largely derived from the MERGE model, Manne et al 1995.

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