II. General equilibrium approaches—theory

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# II. General equilibrium approaches—theory - PowerPoint PPT Presentation

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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Presentation Transcript
II-AA. Analytical tools
• Producer’s problem
• Consumer’s problem
• Aggregate income and expenditure
II-AEquilibrium of a two-sector economy

y2

p = p2/p1

y = (y1, y2)

m2

c = (c1, c2)

u

y1

m1

• Define tariff-distorted prices p* = p(1 + t).
• TEF is now:
• e(p*, u) = r(p*, v) + t•m
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.
• 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-ASalter-Swann diagram

T

RER = pN/pT

(yT, yN) = (cT, cN)

N

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.

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.