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 consumers 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 consumers lifetime budget
constraint:

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Equation 13.5
The governments 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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