This paper analyzes the impact of policy-induced exchange rate changes
(devaluations) on the functional income distribution between owners of
different production factors in a dynamic general equilibrium model of the
small open economy that produces traded and non-traded goods. In this
heterogeneous agents’ optimization model, workers are assumed to move
freely between the sectors with a flexible wage rate while installed capital is
sector-specific and new capital goods are constructed by combining non-traded
inputs with imported machines. Various simulation results show that real
return on capital in the nontradables sector always falls while that in the
tradables sector invariably jumps up on impact following devaluation.
Interestingly, real wage jumps up, stay unchanged or falls on impact following
devaluation depending mainly on relative factor intensity of the two sectors and
the share of imported machines in production of capital goods. The results of
this heterogeneous agent model are strikingly similar, qualitatively and
quantitatively, to those of the representative agent model analyzed in
Won(2008), which may provide a rationale for using a rather simpler
representative agent model.