Bilateral trade in open economy macroeconomic models

Centrally Planned Economies (CPE's) use administrative controls in their foreign trade, their response to market signals is weak or non-existent. This study uses static general equilibrium models to investigate the effect of trading with a CPE on a market economy's prices in case of disturbances, such as changes in the preferences or in the level of spending. The results are compared with a case when the market economy, that is called the home country, conducts trade with a similar market economy, rather than trading with a CPE.;The result is different if the home country imports an intermediate good. In case of an increase in the price of the imported intermediate good the CPE exerts a stabilizing effect on the home country's prices, because, due to the trade balance constraint, the CPE's imports from the home country are directly and positively related to the price of the intermediate good.;Differences in the qualities of the potential foreign trading partners' behavior make price adjustment different in a market economy. This result is ought to be considered by policy-makers when they make decisions about the orientation of their country's trade policy.;Two alternative assumptions are made about the CPE's trading behavior: it either fixes its imports and adjusts its exports or it fixes its exports and adjusts its imports to achieve balance in the foreign trade. Using models that incorporate two finished goods and two countries only the finding is that, if the CPE fixes its imports, this special trading behavior destabilizes the home country's relative prices. If the CPE fixes its exports then the results depends on how elastic the alternative partner market economy's import demand is. These results are generalized in a three country model.