in relative prices and be able to substitute between factors of production subject to constant returns to scale in the process of profit maximization. This profit maximization implies that factors receive their marginal productivity. Once determined, these factors are combined with fixed-share intermediates using a Leontief specification. The use of fixed shares reflects the belief that the required combination of intermediates per unit of output, and the ratio of intermediates to value-added, is determined by technology rather than by the decision-making of producers (Thurlow, 2008).

Producers can substitute between domestically sold and exported commodities based on a constant elasticity of transformation (CET) function, which distinguishes between exported and domestic goods, and by doing so, captures any time or quality differences between the two products (Lofgren et al., 2002). Furthermore, the model includes three macro-economic balances or closures for government account balance, external account balance, and savings-investment account. To bring about equilibrium in the various macro accounts, these closure rules represent important assumptions about the way institutions operate in the economy and can substantively influence the results of the model. Closure rules are chosen due to their appropriateness in the Ethiopian context. For the current account, it is assumed that the level of foreign savings is fixed, and the exchange rate is flexible. This implies that during shortage of foreign savings, the real exchange rate adjusts by simultaneously reducing spending on imports and increasing earnings from exports to maintain a fixed level of foreign borrowing. In the government account, the tax rates are held constant and government savings are flexible implying the government finances its deficit through borrowing and is constrained in raising taxes to cover additional public spending. Savings-driven investment closure is adopted in which investment adjusts endogenously to the availability of loanable funds, and the savings rates of domestic institutions are fixed to ensure that savings equals investment spending in equilibrium. The consumer price index is chosen as the numéraire such that all prices in the model are relative to the weighted unit price of households’ initial consumption bundle. The model is also homogenous of degree zero in prices, implying that a doubling of all prices does not alter the real allocation of resources (Diao et al, 2011).

This CGE model is calibrated to the 2010/11 Social Accounting Matrix (SAM) data of the country (Ahmed et al, 2017). The SAM is a comprehensive, economy-wide data framework, typically representing the economy of the nation and consistent with macro to micro accounting framework. Its construction is based on Ethiopia’s national accounts, the Household Income Consumption and Expenditure Survey (HICES), Agricultural Sample Survey (AgSS), and other important data. Given that the SAM is a table which summarizes the economic activities of all agents in the economy, it typically includes households, enterprises, government, and the rest of the world (RoW). The relationships included in the SAM include purchase of inputs (goods and services, imports, labor, land, capital, etc.), production of commodities, and payment of wages, interest rent and taxes, savings and investment, and the rest of the world.

This 2015/16 EDRI/IFPRI SAM is disaggregated into 69 activities: 31 in agriculture sector, 26 in industry, 11 in service, and 1 mining sector; 74-commodities; 13-factors<sup>9</sup> , and 15<sup>10</sup> -households. The SAM also has government, different taxes, saving-investment, inventory and rest of the world accounts to show the interaction of different institutions within the economic system.

As briefly described above, this general equilibrium modeling involves the interactions of different actors in the economy including the activities that are linked to government income through value added and sales taxes; the households that supply and determine the level of factors of production and have implications on their income and subsequent level of direct income tax; and the level of imports which

> 9 Eight types of labor: four types in each location (urban and rural) by education type (no education, primary education, secondary education, and tertiary education), five types of capital (land, crop, livestock, mining, and other capital).

> 10 Five farming households, five non-farming rural households, and five urban households.

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