Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 13 International Trade in Goods and Assets

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Chapter 13

International Trade in Goods and Assets

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 13-2

Chapter 13 Topics

• A two-good model of a small open economy.

• The benefits from trade, and the macroeconomic effects of a change in the terms of trade.

• A two-period small open economy model: the current account.

• Production, investment, and the current account.


A two-good model of a small open economy

• Production possibilities frontier.

• Indifference curves of the representative consumer.

• Illustrate equilibrium when there is not trade, and when the SOE is a price-taker on world markets.


Figure 13.1 Production Possibilities Frontier for the SOE


Figure 13.2 Indifference Curves of the Representative Consumer in the SOE


Equation 13.1

In equilibrium the consumer maximizes when his or her marginal rate of substitution equals the relative price of the two goods.


Equation 13.2

Optimal behavior by firms implies that the marginal rate of transformation is equal to the relative price of the two goods in equilibrium.


Figure 13.3 Equilibrium in the SOE with No Trade


Equation 13.3

Representative consumer’s budget constraint when there is trade with the rest of the world:


Figure 13.4 Production and Consumption in the SOE with Trade


The Effects of Trade

Welfare must increase for the SOE when trade opens up, no matter which good the SOE initially imports.


Figure 13.5 An Increase in Welfare When Good a Is Imported


Figure 13.6 An Increase in Welfare When Good b Is Imported


An Increase in the terms of trade

• Effects depend on which good is initially imported.

• Income and substitution effects are an important element in analyzing the implications of a change in the terms of trade.


Figure 13.7 An Increase in the Terms of Trade when Good a Is Initially Imported


Figure 13.8 An Increase in the Terms of Trade when Good b Is Initially Imported


A Two-Period Small Open Economy Model

• Two periods – current period and future period.

• Representative consumer with exogenous current-period and future-period incomes.

• The SOE is a price-taker on world credit markets – the real interest rate is exogenous.

• The current account surplus here is equal to savings in the SOE, as there is no investment.


Equation 13.4

The representative consumer’s lifetime budget constraint:


Equation 13.5

The government’s intertemporal budget constraint:


Figure 13.9 The Two-Period Small Open-Economy Model


Figure 13.10 Deviations from Trend in the Current Account Surplus and GDP


Figure 13.11 Government Spending and Taxes


Figure 13.12 The Twin Deficits?


A Small Open Economy Model with Production and Investment

• Works the same as the real intertemporal model, except the real interest rate is determined on world credit markets, and given to the SOE.

• Current account surplus always adjusts so that the aggregate supply and aggregate demand curves intersect at the world real interest rate.


Figure 13.13 A Small Open-Economy Model with Production and Investment


Figure 13.14 An Increase in the World Real Interest Rate


Figure 13.15 A Temporary Increase in Government Spending


Figure 13.16 A Permanent Increase in Government Spending


Figure 13.17 An Increase in Current Total Factor Productivity


Figure 13.18 An Increase in Future Total Factor Productivity


Figure 13.19 Investment as a Percentage of GDP


Figure 13.20 An Increase in the Capital Stock

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Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 13 International Trade in Goods and Assets