II. General equilibrium approaches—theory II-A II. General equilibrium approaches—theory
A. Analytical tools Producer’s problem Consumer’s problem II-A A. Analytical tools Producer’s problem Consumer’s problem Aggregate income and expenditure Markets and trade Distortions and non-traded goods
II-A Producer’s problem
II-A
II-A Consumer’s problem
II-A
Aggregate budget constraint II-A Aggregate budget constraint
Equilibrium: Walras’ law II-A Equilibrium: Walras’ law
Equilibrium of a two-sector economy II-A Equilibrium of a two-sector economy y2 p = p2/p1 y = (y1, y2) m2 c = (c1, c2) u y1 m1
II-A
Trade policy distortions II-A Trade policy distortions E.g. trade policy. Define tariff-distorted prices p* = p(1 + t). TEF is now: e(p*, u) = r(p*, v) + t•m
Externalities E.g. env. externality in production II-A Externalities E.g. env. externality in production TEF is now: e(p, u) = r(p, v) - z'y where z is qty of pollution per unit of y produced. Env. externality in consumption: u = u(c, z) ==> e(p, z, u) NB assumption of separability.
II-A Non-traded goods Goods may be non-traded (or effectively so) for intrinsic and policy reasons. If one good is non-traded, for this, mn = 0. Equilibrium now requires additional equation: e(p, u) = r(p, v) en(p, u) = rn(p, v) and solves for pn as well as agg. welfare. With endog. prices, preferences play a role.
II-A Salter-Swann diagram T RER = pN/pT (yT, yN) = (cT, cN) N
II-A Effects of growth T N
Equilibrium: macro view II-A Equilibrium: macro view (A) Base model Y = C + I + G + (X - M) let C + I + G = E be agg. dom. spending; so Y - E = X - M in equilibrium. Internal balance <==> external balance (B) With taxes and int’l capital flows Y + R - T = C + I + G - T + (X + R - M) let Y + R - T - C = S be agg. dom. savings; so X + R - M = (S - I) + (T - G) in eq’m. Curr. acc. surplus is equal to excess of savings over investment plus gov’t budget surplus.
II-A Summary Basic tools reflect our assumptions about technology, preferences and behavior Representative agent models Focus of trade as determinant of price formation Aggregate budget constraints impose internal consistency Many forms of complication are possible.
II-A Q & A: basic tools