Introduction

Rural areas are often targeted for economic development. Ex-ante analysis of rural development policies is challenging because of the interdependencies between rural and urban areas which allow for ‘leakages’ of benefits through sales of urban products to rural consumers and through urban residents' ownership of rural land and capital. Conversely, the areas are not interdependent enough to assume a single market for goods, services and factors. Rural and urban markets are segmented because of the distances between them and/or because of habits or policies that restrict exchange. They are integrated to the extent that transport costs are not prohibitively high, and that rural and urban versions of the ‘same’ items are, in fact, substitutes. Thus, rural and urban areas should be modelled as separate but interdependent.

This chapter describes a rural–urban computable general equilibrium (CGE) model and the bi-regional social accounting matrix (SAM) needed to operationalise it. Three main steps are involved in the construction of any applied general equilibrium model. The first step is to formulate the theoretical general equilibrium model (see, for example, Dervis, deMelo and Robinson, 1982; Condon, Dahl and Devarajan, 1987). Second, develop a balanced SAM that exhaustively documents the observed flows of goods, factors, revenues and expenditures in the economic system of interest. Third, choose the functional forms and calibrate the parameters of the CGE model so that the solution for the base period replicates the data in the balanced, base-year SAM.