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Chapter 13
International
Trade in
Goods and
Assets
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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.
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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.
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Figure 13.1 Production
Possibilities Frontier for the SOE
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Figure 13.2 Indifference Curves of the
Representative Consumer in the SOE
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Equation 13.1
In equilibrium the consumer maximizes when his
or her marginal rate of substitution equals the
relative price of the two goods.
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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.
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Figure 13.3 Equilibrium in the
SOE with No Trade
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Equation 13.3
Representative consumer’s budget constraint when
there is trade with the rest of the world:
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Figure 13.4 Production and
Consumption in the SOE with Trade
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The Effects of Trade
Welfare must increase for the SOE when trade
opens up, no matter which good the SOE
initially imports.
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Figure 13.5 An Increase in
Welfare When Good a Is Imported
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Figure 13.6 An Increase in
Welfare When Good b Is Imported
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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.
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Figure 13.7 An Increase in the Terms
of Trade when Good a Is Initially
Imported
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Figure 13.8 An Increase in the Terms
of Trade when Good b Is Initially
Imported
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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.
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Equation 13.4
The representative consumer’s lifetime budget
constraint:
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Equation 13.5
The government’s intertemporal budget constraint:
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Figure 13.9 The Two-Period
Small Open-Economy Model
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Figure 13.10 Deviations from Trend in
the Current Account Surplus and GDP
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Figure 13.11 Government
Spending and Taxes
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Figure 13.12 The Twin
Deficits?
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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.
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Figure 13.13 A Small Open-Economy
Model with Production and Investment
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Figure 13.14 An Increase in
the World Real Interest Rate
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Figure 13.15 A Temporary
Increase in Government Spending
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Figure 13.16 A Permanent
Increase in Government Spending
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Figure 13.17 An Increase in
Current Total Factor Productivity
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Figure 13.18 An Increase in
Future Total Factor Productivity
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Figure 13.19 Investment as a
Percentage of GDP
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Figure 13.20 An Increase in
the Capital Stock
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