Top-down and bottom-up models are the two basic approaches to examine the linkages between the economy and specific GHG emitting sectors such as the energy system. Top-down models evaluate the system from aggregate economic variables, whereas bottom-up models consider technological options or project-specific climate change mitigation policies. IPCC SAR on economic and social dimensions (IPCC, 1996a, Chapter 8) includes an extensive discussion on the differences between top-down and bottom-up models. It concluded that the differences between their results are rooted in a complex interplay among the differences in purpose, model structure, and input assumptions (IPCC, 1996a, Section 8.4.3).

In previous studies, bottom-up models tended to generate relatively low mitigation costs (negative in some cases), whereas top-down models suggested the opposite. Understanding why this range of costs arises requires exploration of the differences in the two modelling approaches.

The terms “top” and “bottom” are shorthand for aggregate and disaggregated models. The top-down label comes from the way modellers apply macroeconomic theory and econometric techniques to historical data on consumption, prices, incomes, and factor costs to model the final demand for goods and services, and the supply from main sectors (energy sector, transportation, agriculture, and industry). Some critics complain, however, that aggregate models applied to climate policy do not capture the needed sectoral details and complexity of demand and supply. They argue that energy sector models were used to explore the potential for a possible decoupling of economic growth and energy demand, which requires “bottom-up” or disaggregated analysis of energy technologies. Some of these energy sector technology data were, however, integrated in a number of top-down models, so the distinction is not that clear-cut.

Macroeconomic models are often also detailed, but in a different way to bottom-up models. Top-down models account for various industrial sectors and household types, and many construct demand functions for household expenditures by summing “individual demand functions”. Such functions can facilitate a reasonably detailed assessment of economic instruments and distributional impacts of climate change mitigation policies.

Another distinction between the top-down and bottom-up approaches is how behaviour is endogenized and extrapolated over the long run. Econometric relationships among aggregated variables are generally more reliable than those among disaggregated variables, and the behaviour of the models is more stable with such variables. It is therefore common to adopt high levels of aggregation for top-down models when they are applied to long time frames (e.g., beyond 10–15 years). The longer the period the greater the aggregation gap expected between top-down and bottom-up models.

Top-down models examine a broad equilibrium framework. This framework addresses the feedback between the energy sector and other economic sectors, and between the macroeconomic impacts of climate policies on the national and global scale. As such, early top-down models usually had minimal detail on the energy-consuming side of the economy. Specific technologies were not directly captured. In contrast, bottom-up models mimicked the specific technological options, especially for energy demand. Attention to the detailed workings of technologies required early modellers to pass over the feedbacks between the energy sector and the rest of the economy.

Top-down and bottom-up models also have different assumptions and expectations on the efficiency improvements from current and future technologies. Bottom-up models often focus on the engineering energy-gains evident at the microeconomic level and detailed analysis of the technical and economic dimensions of specific policy options. The sector-specific focus generates lower costs relative to the top-down model, which captures the costs caused by the greater production costs and lower investment in other sectors.

The basic difference is that each approach represents technology in a fundamentally different way. The bottom-up models capture technology in the engineering sense: a given technique related to energy consumption or supply, with a given technical performance and cost. In contrast, the technology term in top-down models, whatever the disaggregation, is represented by the shares of the purchase of a given input in intermediary consumption, in the production function, and in labour, capital, and other inputs. These shares constitute the basic ingredients of the economic description of a technology in which, depending on the choice of production function, the share elasticities represent the degree of substitutability among inputs.

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