ii general equilibrium approaches theory n.
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II. General equilibrium approaches—theory. A. Analytical tools. Producer’s problem Consumer’s problem Aggregate income and expenditure Markets and trade Distortions and non-traded goods. Producer’s problem. Consumer’s problem. Aggregate budget constraint. Equilibrium: Walras’ law.

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a analytical tools
II-AA. Analytical tools
  • Producer’s problem
  • Consumer’s problem
  • Aggregate income and expenditure
  • Markets and trade
  • Distortions and non-traded goods
equilibrium of a two sector economy
II-AEquilibrium of a two-sector economy

y2

p = p2/p1

y = (y1, y2)

m2

c = (c1, c2)

u

y1

m1

trade policy distortions
II-ATrade 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
II-AExternalities
  • 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.
non traded goods
II-ANon-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.
salter swann diagram
II-ASalter-Swann diagram

T

RER = pN/pT

(yT, yN) = (cT, cN)

N

equilibrium macro view
II-AEquilibrium: 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.

summary
II-ASummary
  • 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.