7- Net Exports, Equilibrium Income and Economic Policy Flashcards
Exports
Exports are goods and services made in the UK but sold abroad.
How are exports treated?
As exogenous
Determinants of export level
- Foreign GDP
Imports
Imports are goods and services made abroad but purchased by UK residents.
How are imports treated?
Endogenous- as they depend on income of domestic residents.
Determinants of import levels
- Domestic income
- Price competitiveness of foreign goods e.g. as home prices rise relative to foreign prices, the demand for imports rise.
Import function
IM= m0 - mY
0<m<1- the marginal propensity to import
Net export function relation to GDP
- Desired net exports are negatively related to GDP because of the positive relationship between desired imports and GDP and the assumption that exports are exogenous.
Net export function
NX= x0 - mY
x= (X- m0)
Shifts in the net export function
- Changes in foreign GDP
- Changes in relative international prices
- Changes in the exchange rate
What changes the slope of the net export function
Anything that affect the proportion of GDP that home consumers wish to spend on imports will change the slope of the net export function.
How changes in foreign GDP shifts the net export function?
- An increase in foreign GDP will lead to an increase in the quantity of domestically produced goods demanded by foreign countries.
How changes in relative international prices shifts the net export function?
Any changes in prices of home-produced goods relative to those of foreign goods will cause both imports and exports to change as if domestic prices rose relative to foreign prices, exports will seem expensive and will fall- so domestic residents will buy more imports.
What causes relative international prices to change?
- Inflation (assuming exchange rates are constant).
- Exchange rate (assume prices held constant)
How the exchange rate shifts the net export function?
Depreciation of sterling will make imports more expensive for domestic residents and UK exports cheaper for foreigners. This is because UK residents will get less foreign currency for each pound and foreigners will get more pounds for each unit of their own currency.
Full economy multiplier
k= 1/ (1-b(1-t) + m)
Smaller than previous multiplier
Other way to determine equilbrium GDP
- Where injections= withdrawals
- In simple model where S+I
- In open economy where:
S + T + IM= I + G + X
How effectiveness of fiscal policy changes in an open economy?
Higher income from fiscal expansion leads to higher imports which are a withdrawal from the circular flow of income.
Stabilization policy
Any policy that attempts to influence GDP through fiscal measures such as changes in taxes and gov spending.
How to work out how much a AE component increase causes a change in equilibrium GDP?
= change in AE component x the multiplier
What will changes in tax rates cause?
- Changes in disposable income, therefore consumption.
- The marginal propensity to spend out of GDP, c.
- Shift in AE, therefore change in equilibrium GDP.
- The lower the tax rate, the higher the multiplier.
Factors that change the slope of the AE curve
- MPC and MPS
- Rate of income tax
- Propensity to import
Balanced budget multiplier
= Change in GDP/ Change in gov spending that brought it about.
How balanced budget multiplier works?
- If the gov raised 100 million in taxes and used that money to buy domestically produced goods- we assume a balance.
- But, if the MPC= 0.75- consumption would only fall 75 million rather than 100 million so 100 + 25 > 100- so expansionary effect.
Deficit-financed
When G is increased with no corresponding increase in tax rates.
If there is no increase in tax rates, there is no consequent decrease in consumption to offset the increase in G.
How monetary policy affects AE?
Through changes in the interest/bank rate and money supply.
Relationship between the marginal propensity to import and marginal propensity to spend
Because imports are subtracted to obtain net exports (X-IM) the greater the marginal propensity to import, the lower the marginal propensity to spend on domestic products and lower the multiplier.
