Modelling the health related benefits of environmental policies - a CGE analysis for the eu countries with gem-e3

2.3. The health impacts of air pollution on the production sectors

The GEM-E3 Europe model distinguishes 18 productive branches. For each
branch domestic output (XD) is produced according to a nested CES production
technology, using capital, labour, electricity, fuels and materials as inputs. For
simplification, the presentation here considers only one level of the nested production
function and only two inputs, capital (K) and labour (L).

The extension of the GEM-E3 model takes into account that air pollution affects
the number of days active people are ill. Within the institutional setting of the EU
countries this is assumed to influence only partly the income of the consumers, which
implies that the productivity of labour in the production sectors is affected. A rise in air
pollution reduces labour productivity: more labour is needed to produce one unit of
output, this increases the cost of labour and induces a substitution towards the other
production factors.

For a given capital price r and gross wage rate w^g, the cost minimization
problem of production sector ( ∀ ) is given by:

rK + w^gL

σj is the elasticity of substitution. dKj and dLj are the share parameters of the CES
production function. γ is the percentage of working days lost due to air pollution. It is a
positive function of the ambient concentration of the M pollutants (∂γ/∂Am ≥ 0, ∀ m).

This cost minimization problem leads to the following input demand functions
for sector j:

1-γ(A₁,...,A_m)

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