Chapter 2 - THE Closed BASIC GE MODEL: AUTARKY SOLUTIONS In...

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THE Closed BASIC GE MODEL: AUTARKY SOLUTIONS In this closed basic model, there is Autarky or Self-Sufficiency (a self-sufficient country abstains from trade, i.e., the economy is a closed economy). The Autarky Solution : Production, consumption and relative prices are determined simultaneously (S*, T* and P* S /P T ) The Autarky Solution in the GE model : production, consumption and relative prices are determined simultaneously. The solution is achieved after the producers and consumers agree on the same relative price ( one price ). The producers’ relative price is called the relative price the producers are asking for . It’s the slope of the PPF. The consumers’ relative price is the relative price the consumers are willing to pay . It’s the slope of the community indifference curve Two ways to derive the solution: 1. Using the PPF and one of the CICs. 2. National Supply (NS) and National Demand (ND). 1. Solution of Closed Basic Model: The PPF and CIC Consumers: Maximize satisfaction Producers: Maximize total revenue and try to meet consumers’ demand. The solution is determined by the tangency between the CIC and the PPF. Slope of CIC = Slope of PPF (or one relative price P S /P T ) Relative price consumers willing to pay = Relative price producers asking for The slope of the CIC is the relative price P S /P T the consumers are willing to pay, while the slope of the PPF is the relative price P S /P T the producers are asking for . Solution for the Closed Basic Model: Equilibrium condition: slopes of CIC and PP are equal Relative price producers asking for is a result of Assumption 5 where the relative price equals the slope of the PPF at the production point, which is the opportunity cost.
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Case 1 : The Autarky Solution: PPF with Constant Opportunity Cost Here, the PPF is a straight line since the opportunity cost is constant. Thus, the PPF determines the price line because by A.5 we have P S /P T = constant = T/ S (e.g., slope of price line = slope of PPF). Then the price line and the PPF coincide or the producers determine the relative price. The
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Chapter 2 - THE Closed BASIC GE MODEL: AUTARKY SOLUTIONS In...

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