This article presents a general equilibrium model capable of assessing the impact of foreign price shocks on the real side of the oil‐based developing economies. The theoretical model departs from previous work in this area at least in that (1) the model takes into account endogenous income and price responses in all sectors of the economy; (2) it has two traded goods (exports and imports) and a non‐traded good; (3) it explicitly addresses the inherent open and small economic nature of developing countries; and (4) besides adjustments in the endogenous domestic prices, the model also allows for other structural adjustments. As such, the model combines the neoclassical macro theory with the structural micro approach. Empirical evidence deduced from an important oil‐based developing economy (Saudi Arabia) appears quite consistent with the model theoretical implications.
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