Macroeconomic Effects of Changes in Tourism Demand: A Simple Dynamic Model

Abstract

This paper studies the macroeconomic effects of an increase in tourism demand due both to an exogenous increase in foreigners' income and to tourism marketing activities in a small country which specializes in tourism production. Using a dynamic general equilibrium model, the authors show that an increase in tourism demand leads to an increase in the relative price of domestically produced tourism services and increases tourism production. Because the dynamic transition is characterized by capital accumulation and a current account deficit, the economy ends up with a higher capital stock but a lower stock of net foreign assets. Higher foreign income has a welfare-increasing effect, whereas an increase in marketing expenditures has ambiguous effects on residents' consumption and welfare. The authors also discuss the effects of a temporary demand stimulus, which is nonetheless shown to have permanent effects on the country's net foreign asset position and agents' consumption.