Download TNT (Tradable/Nontradable) DEBT MODEL

TNT (Tradable/Nontradable) DEBT MODEL
Nontradable goods: Goods that can only be produced & consumed within a country
because they are too costly to trade. i.e. services like haircuts, apartment rentals,
construction equipment, transportation
Tradable goods: all other goods that can be imported/exported i.e. agriculture, mining,
manufactured goods
Model assumptions:
1. Labor & capital are used in the production of both tradable and nontradable goods
2. Fixed level of capital
3. Decreasing Marginal Productivity of labor: as you add another worker, his/her
additional contribution to the total output will be less than the previous worker
PPF = production possibilities frontier shows the maximum amount of one type
of good that can be produced in an economy given the production of the other
4. The relative price ratio (PT/ PN) is the slope of the PPF at any point.
The slope measures the cost of producing an additional unit of tradable goods in
terms of nontradable goods. We can think of this ratio as the real exchange rate (the
relative price of tradable goods)
5. The relative price is determined by technology (PPF) and aggregate demand
1. DEBT: At point B, country consumes more tradables than it produces
Assuming a fixed level of nontradables, the trade deficit (and therefore debt)
will equal the distance AB
nontradables
A
B
tradables
2.) PAYING OFF DEBT
in order to pay off last period's trade deficit, the country will need to have a trade
surplus (produce more tradables than it consumes...somewhere inside the PPF)
Suppose now consume at point E and produce at point D.. surplus ED
By changing from production point A to D, the relative price of
tradable/nontradable goods increases. The decreased demand for nontradables relative to
tradables results in unemployment in the nontradable sector. Prices for nontradables fall
relative to tradables (this is a real exchange rate depreciation....more expensive to buy
traded goods) There is a shift from nontradable to tradable production.
nontradables
A
E
B
D
tradables
3.) WHAT IF UNPRODUCTIVE INVESTMEST ACTUALLY LED TO THE
SHRINKING OF THE PPF?
the trade surplus in the second period would be even smaller
nontradables
A
E
B
F
D
tradables
LDCs did have large trade surpluses used to finance payments