II-B
II. General equilibrium
approaches—theory
A. Ana lytical tools : produce rs, consumers, markets and trade
B. Geometric models of trade and environment
- What are we measuring? Environmental and we lfare outcome s
C. Comparative static result s and standa rd theo rems
D. Simple models of trade and env ir onmental poli cy
- Environmental and welfare costs of trade poli cies.
1
II-B
Geometric models
1. Standard model of resource allocation,
production, trade and welfare
2. An open economy with pollution
3. Measuring pollution and economic
welfare
2
II-B
A simple GE model
• Assume:
– Two goods produced and consumed
– Each good is produced using two factors
• Constant returns to scale
– One factor (labor) is intersectorally mobile; the others
are “specific” to sectors
– Markets are complete and competitive
• Prices are set in world markets
3
II-B
y2
Production
Possibiliti es
b = (y1, y2)
ƒ2(v)
y1
Labor
a = (L1, L2)
Resource
All ocation
ƒ1(v)
Labor
1. Gene ral equili brium of the 2 X 3 econo my
4
II-B
Spot test!
1. Use the diagram to show the value of total
income.
2. For a given set of consumer preferences,
show the pattern of trade.
3. Demonstrate that (a, b) is an equilibrium
(hint: Walras’ Law).
5
II-B
y2
h
b
ƒ2(v)
Inco me (in terms
of y1)
y1
Labor
a
ƒ1(v)
Labor
Gene ral equili brium of the 2 X 3 econo my
6
II-B
y2
b = (y1, y2)
ƒ2(v)
d = (y1', y2'')
y1
L
a = (L1, L2)
c = (L1', L2')
ƒ1(v)
L
2. Produc tion and resource all ocation effects of a price
chang e
7
II-B
Spot test!
•
What happens
to factor returns
when relative
output prices
change?
1. Returns to specific
factors rise (fall) as
sectoral output rises
(falls)
2. Wage change
depends on laborintensity of
expanding sector
8
II-B
y2
b
f
ƒ (v)
2
b
y1
L
a
e
ƒ1(v)
L
3. Effects of an increase in the labor force
9
II-B
Spot test!
1. What happens to
the structure of
output as specific
factor endowments
increase?
2. What is the effect
of technical
progress in a
sector?
1. The sector using that
factor expands--and
the other contracts
2. That sector’s output
expands, and the
other’s output
contracts
10
II-B
An open economy with pollution
• The Antweiler, Copeland, Taylor (2001) diagram
– ‘Clean’ and ‘dirty’ goods
– Comparative advantage in dirty good
– Tariff on imports of clean good
• Effects of trade liberalization:
– scale
– composition
– technique
11
II-B
Clean
good
UW
UT
A
pT
C
B
pW
YT
YW
Dirt y good
zA
zC
z=2()x
Composition
zB
Scale
zS
Techn ique
z=1()x
Poll ution
Sour ce: Adapted from Antweil er et al. 2001
12
II-B
Factor endowment growth
• Scale and composition effects
13
II-B
Clean
good
C
E
D
pW
Dirt y good
zC
zE
zD
Composition
z=3()x
Scale
zI
Poll ution
Techn ique
z=1()x
14
II-B
Environment and economic
welfare
• ACT model tells us what happens to
pollution.
• But consumer utility: u = u(c, -z)
– Price or endowment changes affect c as well as
z: what is the change in net welfare?
– example: trade liberalization
15
II-B
Welf are
R – value of output
C- utilit y from
env ir onmental
qua lit y
Tariff
16
II-B
Spot test!
Q. In the previous example, what is the optimal
tariff, and how is it calculated?
A. Where absolute values of slopes of R and C are
equal (marginal environmental benefit=marginal
cost in terms of consumption)
B. Q. What is the optimal tariff on imports of a
dirty good?
C. A. t = 0.
17
II-B
Summary and conclusions
•
•
•
•
Assumptions about optimizing behavior
Assumptions about markets and technology
Assumptions about trade
Models must make assumptions explicit and be
demonstrably consistent
• Complications can be introduced, but at a cost
• Target of analysis is important. Is it the
environment only? Or a broader concept of
welfare?
18
II-B
For next sessions
• Review duality and basic concepts, if
necessary
– Buffie, or equivalent.
• Look at OEE Ch. 2 models, and/or Ulph
(1999).
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