Production and the Trade Balance in a Small Open Economy

Production and the Trade Balance in a Small Open Economy

The trade balance is built directly into a factor proportions model of production. A wealth stockpile of the exported good is maintained, growing when the small open economy has a surplus and shrinking with a deficit. Income and prices determine consumption of exports and imports, while production adjusts to maintain full employment and competitive pricing. The trade balance effects of an import tariff and an export subsidy (equivalently, a devaluation) depend on factor intensity, factor substitution, demand, and factor endowments. Changing factor endowments have no net effect on the trade balance, a reflection of factor price equalization.