Endogenous Capital Utilization in CGE Models: A Mongolian Application with the PEP-1-1 Model

This paper extends the PEP-1-1 model (a static computable general equilibrium, or CGE, model for small open economies) to incorporate variable capital utilization. It argues that CGE models with fixed sectoral capital may underestimate the impact of shocks in the short run by ignoring industries’ adjustment of their capital utilization rate (or intensity of use) in response to changes in their economic environment. The model is calibrated to a 2014 Mongolian social accounting matrix. An increase in the export price of coal is considered as a shock for demonstration purposes. Compared to the standard PEP-1-1 model the impact of the shock is larger in the expanded model. In addition, the results of the PEP-1-1 model are derived as a special case of the model involving capital utilization.