1. II. General equilibrium approaches—theory
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II. General equilibrium approaches—theory

2. A. Analytical tools Producer’s problem Consumer’s problem
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A. Analytical tools
Producer’s problem
Consumer’s problem
Aggregate income and expenditure
Markets and trade
Distortions and non-traded goods

3. II-A
Producer’s problem

4. II-A

5. II-A
Consumer’s problem

6. II-A

7. Aggregate budget constraint
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Aggregate budget constraint

8. Equilibrium: Walras’ law
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Equilibrium: Walras’ law

9. Equilibrium of a two-sector economy
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Equilibrium of a two-sector economy y2
p = p2/p1
y = (y1, y2) m2
c = (c1, c2) u y1 m1

10. II-A

11. Trade policy distortions
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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

12. Externalities E.g. env. externality in production
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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.

13. 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.

14. II-A
Salter-Swann diagram T
RER = pN/pT
(yT, yN) = (cT, cN) N

15. II-A
Effects of growth T N

16. Equilibrium: macro view
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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.

17. 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.

18. II-A
Q & A: basic tools