ECON 355 TERM 2

Social Accounting Matrix (SAM):

• this is an extension of the input-output model
• the model represents government, the rest of the world, etc.
• general equilibrium vs. partial equilibrium:
• partial equilibrium:
• partial equilibrium can be illustrated by considering the effect of a
change in the wage on employment:
wage
(VMPL)
w1 demand for labor

w0

L1 L0 labor

when the wage increases from w1 to w0, the amount of labor employed
decreases from L0 to L1
• however, this model does not consider all the effects of a higher wage;
there may be other consequences, for example:
1) some people will lose their jobs while others earn a higher
wage, which will have an effect on total income – this, in turn,
affects the demand curves for different goods
2) because of the higher wage, the firm(s) could use different
technology or move to another country
• thus, partial equilibrium analysis does not follow the effects of a change
all the way through the entire economy
• general equilibrium:
• in contrast to partial equilibrium, general equilibrium considers how all
markets interact with each other and determines all secondary, tertiary,
etc. effects
• computable general equilibrium (CGE) models:
• CGEs are quantifiable (computable), multi-sector models
• they model the entire economy using a set of equations; once the model is set
up, it can be used to make predictions; for example, if the minimum wage
decreases, a general equilibrium model can trace through the effects this would
have on the rest of the economy
• economists have tried to use general equilibrium models to predict the effect of
policies
• however, a general equilibrium model is only as good as its assumptions and
needs to simplify; thus, the model allows an effect to be traced through the entire
economy but its predictions are not exact

• development versus growth:

• growth refers to an increase in the total output produced or an increase in the
average output per person; however, just because growth occurs does not mean
all people benefit
ECON 355 TERM 2

• if inequality increases as growth proceeds then the incidence of poverty could

increase; thus, how inequality changes with growth is important to consider
• if average income is growing quickly and inequality is growing slowly, even
the poorest can be better off; however, if growth occurs but inequality also grows
quickly, then the poorest might not benefit
• inequality (equality) versus inequity (equity):
• equality and inequality are positive terms – they can be considered apart from
value judgements
• equity and inequity are normative terms – they require a value judgement;
there is controversy over the criteria for determining equity/inequity
• if development has the goal of increasing living standards or reducing poverty
then equality has to be considered, since it is a determinant of how much living
standards improve for how many people
• often, equality is taken into account because of an interest in equity
1) political instability – high levels of inequality can lead to political
instability (guerilla movements, civil wars, general strife) or
detrimental government policy (powerful disaffected minorities can
force interventions that are harmful to the economy)
2) health care – we will return to this later in the course