ABSTRACT
This chapter describes the workings of the economic sphere of a small open political economy treating the policies of the government as given. Transportation costs and other margins on trade are ignored. As a result, the relative price of commodities in the domestic market is exogenously determined by the international relative price and government intervention, which can be expressed in equivalent nominal tariff rate. Consumer demands are generated by maximizing a Cobb-Douglas utility function. Goods market, and the foreign exchange market-clearing conditions simultaneously determine the quantities of net trade on the two goods and the exchange rate at the equilibrium of goods and the foreign exchange markets. As long as the main modelling issue is one concerned with the short-run producers' behaviour, for example rent seeking, the ideal framework should treat some factors as inter-sectorally immobile. The rental rate in each sector will rise more than proportionately as the relative price of its output rises.
