FORWARD-LOOKING ELASTICITIES OF SUBSTITUTION FOR NESTED CES PRODUCTION FUNCTION

Elasticities of substitution energy nested CES production function are the key parameters in General Equilibrium modeling for climate and energy policy. However an estimation and validation of the parameters is not straightforward. One of the ways is to use a historical data. Technological shifts between types of fuels and capital and fuels, observed in the past, potentially could be used to calibrate or econometrically estimate the elasticity coefficients. However, historical trends do not describe all the possible investment options available now. Moreover such estimates will be based on investment decisions made in particular economic condition, policies, and available technological/investment options in the time of decision. Application of the parameters for evaluation of future policy options involves undesirable (and unavoidable) assumption that future technological options are equal or similar to those in the past. A variety of new technological options will be disregarded from the analysis. A more natural way to model technological options is so-called Bottom-Up technological models. Such reference energy systems have an extensive representation of energy sector, and take into account currently available and expected technological options, but consider only part of an economy and lack connectivity with other sectors, f.i. do not provide a demand respond. Therefore their application is usually limited to the energy sector. There are several attempts to connect the top-down (CGE/AGE) and bottom-up models known as “soft” or “hard link”. However both methodologies require significant reduction of the models’ scale or some compromise in connectivity between the models. The methodology proposed in this paper might be considered as another way of hybrid modeling where bottom-up model is used to calibrate parameters for a top-down model. It is expected, the energy nest of a General Equilibrium model should provide results similar to the bottom-up model. Bas...