Small Open Economy (SOE): Small because consumers and firms are price takers and their action doesn’t affect world prices. Open because the economy trade with the rest of the world.
- Suppose two goods: a and b
- Terms of trade (TOTab ) or real exchange rate: the price of good a in terms of good b
- We will find conditions under which the Small Open Economy imports good a and exports good b
The slope of the Production Possibilities Frontier (PPF) is minus the marginal rate of transformation (MRTa,b), and the PPF is concave (see figure below).
Production Possibilities Frontier for the Small Open Economy
The indifference curve of the representative consumer in the small open economy are downward sloping and convex (see figure below).
Indifference Curves of the Representative Consumer in the Small Open Economy
Source:
International Trade in Goods and Assets – “Macroeconomics” by Stephen D. Williamson