The paper studies the dynamics of economic growth caused by an increase in the growth rate of tourism
demand.
We develop a simple dynamic model of a small open economy, which is completely specialized in the
production of tourism services (island economy model), populated by a large number of intertemporally
optimizing agents, deriving utility from consuming an imported good. Tourism services are produced by
means of a simple AK technology by using imported capital, its accumulation associated with adjustment
costs. Moreover, the economy can lend or borrow at the international financial markets at the given world
interest rate. Adjustments in the relative price of tourism services ensure market clearance for tourism
services.
The long-run growth rate of the economy is tied to the growth rate in tourism demand. An increase
in the latter increases thus the economy’s long-run balanced growth rate. In contrast to the standard
one-good small open economy endogenous growth model, where the economy is always on its balanced
growth path, we show that there are transitional dynamics after an increase in the growth rate of tourism
demand. In particular, the short-run growth rate of output rises gradually towards its higher long-run
level, and the market price of tourism increases during transition. Thus, an increase in the growth of
tourism demand, say, caused by higher economic growth abroad, leads to a boom in the small open
economy and increasing terms of trade. Adjustments of the relative price of tourism services (i. e. the
real exchange rate) can therefore not protect the economy from demand disturbances
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