sectors (Y). The primary factors in the model include labor (LAB), physical capital (CAP)
and fossil-fuel resources (RES). Factor markets are assumed to be perfectly competitive.
Labor and physical capital are treated as perfectly mobile across sectors. Fossil-fuel resources
are sector-specific. All factors are immobile between regions. However, the single market
foresees more integrated factor markets leading eventually to free movements of the
production factors within the enlarged single market.
Production
Within each region, each producing sector is represented by a single-output producing
firm which chooses input and output quantities in order to maximize profits. In the model
nested constant elasticity of substitution (CES) cost functions are employed to specify the
substitution possibilities in domestic production between capital, labor, energy and material
(non-energy) intermediate inputs. In non-fossil fuel production (ELE, EIS, OIL, Y)
intermediate non-energy goods and crude oil are employed in fixed proportions with an
aggregate of energy, capital and labor at the top level. At the second level, a CES function
describes the substitution possibilities between labor and the aggregate of capital and the
energy composite. At the third level, capital and the energy composite trade off with a
constant elasticity of substitution. The energy aggregate is, in turn, a nested CES composite of
electricity and primary energy inputs. The primary energy composite is defined as a CES
function of coal and a CES aggregate of refined oil and natural gas. Fossil fuel production
(COL, CRU and GAS) is a CES composite of a sector-specific fossil-fuel resource and a
Leontief aggregate of labor, capital and intermediate inputs. The substitution elasticity
between the specific factor and the Leontief composite is calibrated in consistency with
exogenously given price elasticities of fossil fuel supplies.
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