II' General equilibrium approachestheory

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II. General equilibrium approachestheory
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A. Analytical tools

• Producers problem
• Consumers problem
• Aggregate income and expenditure
• Markets and trade
• Distortions and non-traded goods

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Producers problem
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Consumers problem
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Aggregate budget constraint
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Equilibrium Walras law
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Equilibrium of a two-sector economy
y2
p p2/p1
y (y1, y2)
m2
c (c1, c2)
u
y1
m1
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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) tm

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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)
  gt e(p, z, u)
• NB assumption of separability.

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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.

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Salter-Swann diagram
T
RER pN/pT
(yT, yN) (cT, cN)
N
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Effects of growth
T
N
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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
  ltgt external balance
• (B) With taxes and intl 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 eqm. Curr.
  acc. surplus is equal to excess of savings over
  investment plus govt budget surplus.

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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.

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Q A basic tools