ABSTRACT
As we noted in Chapter 7 the MF model assumes that a single type of good is produced in the economy, which in turn is competitive with a similar good produced abroad. An alternative approach, also widely used in the literature, is to take as a starting point that the economy produces two types of goods, not one: a traded good and a non-traded good. Traded goods are assumed to be perfectly competitive with similar goods produced overseas and hence sell at the same price when expressed in a common currency (the so-called ‘law of one price’)· By contrast, non-traded goods, such as services, housing, are sheltered from overseas competition and their price is assumed to be determined by demand and supply. (Two-sector models are to be found in Prachowny (1984), Dornbusch (1975), Corden (1977) and Montiel (1987).)
