Whether a society adapts to a supply shock or resists it coercively depends on the costs of each action. The more costly is adaptation, the likelier is a coercive response. We consider three kinds of adaptation, each usually costlier than the last: factor substitution, factor mobility, and factor-saving technology. Where substitution is elastic, producers can readily substitute a cheaper factor for one that has become suddenly expensive. Inelastic substitution forecloses that alternative, but often a suddenly devalued factor can exit to a different sector or region where it remains in higher demand. Where neither substitution nor exit is possible, a factor-saving technology or institutions that use a factor more efficiently – e.g., where labor is suddenly scarce, a labor-saving technology – can sometimes be adopted or invented. The puzzle, addressed in the next chapter, is why a new technology does, or does not, arise.

In this chapter, we examine the supply side of an economy as represented in computable general equilibrium (CGE) models. The production data in the social accounting matrix (SAM) depict the production process, in which firms combine intermediate inputs with factors of production to produce goods and services. We use these data to calculate input-output coefficients, which describe the input intensity of production processes. CGE models break down the production technology into parts, depicting how subprocesses are nested within the overall production process. Within each nest, behavioral equations describe producers’ efficiency-maximizing input demands and output levels, subject to their production technology. Export transformation functions, used in some CGE models, describe the allocation of production between domestic and export markets.We also examine the supply and demand structure of a CGE model with a non-diagonal make matrix and a technical appendix examines a case of energy nesting.

In this chapter, we describe final demand by domestic agents – private households, government, and investors – and by the export market. Data in the Social Accounting Matrix (SAM) describe agents’ incomes and the commodity composition of their spending. The computable general equilibrium (CGE) model depicts demand by domestic agents as a three-stage decision. First, consumers decide on the quantities of each commodity in their consumption basket. Second, an “Armington” import aggregation function describes their choice between domestic and imported varieties of each commodity. In some CGE models, a third stage describes the sourcing of imports. We survey functional forms commonly used in CGE models to describe private household preferences. We also introduce the concept of “national welfare,” which is the monetary value of changes in a nation’s well-being following an economic shock.

The focus of this chapter is the trade-off between margin and volume. The analysis is couched within the context of monopoly price-setting. It is shown how to relate the profit-maximzing price to the elasticity demand. It also defines consumer surplus and shows how it may be calculated. The usefulness of these concepts is illustrated via application to the question of regulating a monopolist and double marginalization. The chapter ends by connecting cost functions to production functions.