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 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.

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

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.1 Production Possibilities Frontier for the SOE

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.2 Indifference Curves of the Representative Consumer in the SOE

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Equation 13.1 In equilibrium the consumer maximizes when his or her marginal rate of substitution equals the relative price of the two goods.

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

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.3 Equilibrium in the SOE with No Trade

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Equation 13.3 Representative consumers budget constraint when there is trade with the rest of the world:

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.4 Production and Consumption in the SOE with Trade

Copyright © 2008 Pearson Addison-Wesley. All rights reserved The Effects of Trade Welfare must increase for the SOE when trade opens up, no matter which good the SOE initially imports.

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.5 An Increase in Welfare When Good a Is Imported

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.6 An Increase in Welfare When Good b Is Imported

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

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.7 An Increase in the Terms of Trade when Good a Is Initially Imported

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.8 An Increase in the Terms of Trade when Good b Is Initially Imported

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

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Equation 13.4 The representative consumers lifetime budget constraint:

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Equation 13.5 The governments intertemporal budget constraint:

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 13.9 The Two-Period Small Open-Economy Model

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Deviations from Trend in the Current Account Surplus and GDP

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Government Spending and Taxes

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure The Twin Deficits?

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

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure A Small Open-Economy Model with Production and Investment

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure An Increase in the World Real Interest Rate

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure A Temporary Increase in Government Spending

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure A Permanent Increase in Government Spending

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure An Increase in Current Total Factor Productivity

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure An Increase in Future Total Factor Productivity

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Investment as a Percentage of GDP

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure An Increase in the Capital Stock