5 It is possible to build a partial equilibrium model with multiple sectors and

5 it is possible to build a partial equilibrium model

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_____________________________________________________________ 5 It is possible to build a partial equilibrium model with multiple sectors and countries, and to take into account some of the linkages between sectors. But, the partial equilibrium model will not consider the link between income and expenditure.
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9 Households Firms Factor services of production Factor incomes Investment Savings spending on goods and services goods and services Capital goods International sector The link between the domestic economy and the international sector is captured in the four sets of arrows that lead to and out of the international sector. The international sector is a source of additional goods and services, i.e. imports (black arrow), to the domestic economy. This is matched by a payment flow from domestic residents to foreigners (short brown arrow). But some of the goods and services produced in the domestic economy also go to the international sector as exports (green arrow). This flow outward of goods and services is matched by an inward flow of payments to domestic producers (yellow arrow). If no capital flows are allowed between the domestic economy and the rest of the world, the value of exports must equal the value of imports. (c) Optimizing behaviour in general equilibrium analyses In general equilibrium analysis, the underlying assumption is that of optimizing or "rational" behaviour by economic agents. This is also a maintained assumption in partial equilibrium models, but it is more apparent and explicit in general equilibrium models. So households maximize utility subject to an income constraint and firms maximize profits. This assumption is responsible for generating downward-sloping demand curves and upward-sloping supply curves. Optimizing behaviour by economic agents also lays the foundation for analysing the welfare effects of different equilibria and the policy measures that produce those outcomes. The indicator for assessing the efficiency of an economic system is consumer welfare. This is because the material resources of any economy are there to satisfy human needs. The role of firms or producers is to transform these resources as efficiently as possible into those goods and services that households desire. In other words, the role of firms and of the assumption of profit maximization is to ensure that society produces all that it is capable of producing (i.e. it is on its production possibility frontier and not within). As we explained in the circular flow subsection above, households are the ultimate owners of all factors of production and they receive all factor payments as income - wages, interest, rent as well as profits. Chart 1: Circular Flow in an open economy
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10 A CGE model is a general equilibrium model which uses the power of today's computers to calculate numerically the effects of a particular change that is introduced to the model (e.g. a change in trade policy). It preserves the optimizing assumptions and links between markets that are the hallmarks of the standard general equilibrium model. The
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