Introducing the indirect addilog system in a computable general equilibrium model: a case study for Palestine

A popular functional form for modeling the consumption block of a computable general equilibrium model (CGE) is the Linear Expenditure System (LES) for which the Engel curves are straight lines. To allow for more general shapes two other systems have been proposed in recent literature: An Implicitly Directly Additive Demand System (AIDADS, a generalization of LES) and the Specialized Constant Differences of Elasticities (CDE) system. To calibrate the parameters outside information on all income elasticities and all own price elasticities is needed, whereas LES only requires information on income elasticities and the Frisch parameter. In this paper we consider a special case of CDE, the Indirect Addilog System (IAS) that allows for non-straight Engel curves, whereas its outside data requirement is the same as for LES. The only disadvantage is that all cross price elasticities of a particular price are the same. In many developing countries there is hardly any information on price responses so that the AIDADS and CDE cannot be used. We propose the use of IAS rather than LES. In the empirical part we use IAS in a CGE model for Palestine and show that predictions of macro-economic indicators are remarkably close to those of IMF.