7- Net Exports, Equilibrium Income and Economic Policy

Question 1

Exports

Answer 1

Exports are goods and services made in the UK but sold abroad.

Question 2

How are exports treated?

Answer 2

As exogenous

Question 3

Determinants of export level

Answer 3

• Foreign GDP

Question 4

Imports

Answer 4

Imports are goods and services made abroad but purchased by UK residents.

Question 5

How are imports treated?

Answer 5

Endogenous- as they depend on income of domestic residents.

Question 6

Determinants of import levels

Answer 6

• Domestic income
• Price competitiveness of foreign goods e.g. as home prices rise relative to foreign prices, the demand for imports rise.

Question 7

Import function

Answer 7

IM= m0 - mY
0<m<1- the marginal propensity to import

Question 8

Net export function relation to GDP

Answer 8

• 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.

Question 9

Net export function

Answer 9

NX= x0 - mY
x= (X- m0)

Question 10

Shifts in the net export function

Answer 10

• Changes in foreign GDP
• Changes in relative international prices
• Changes in the exchange rate

Question 11

What changes the slope of the net export function

Answer 11

Anything that affect the proportion of GDP that home consumers wish to spend on imports will change the slope of the net export function.

Question 12

How changes in foreign GDP shifts the net export function?

Answer 12

• An increase in foreign GDP will lead to an increase in the quantity of domestically produced goods demanded by foreign countries.

Question 13

How changes in relative international prices shifts the net export function?

Answer 13

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.

Question 14

What causes relative international prices to change?

Answer 14

• Inflation (assuming exchange rates are constant).
• Exchange rate (assume prices held constant)

Question 15

How the exchange rate shifts the net export function?

Answer 15

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.

Question 16

Full economy multiplier

Answer 16

k= 1/ (1-b(1-t) + m)
Smaller than previous multiplier

Question 17

Other way to determine equilbrium GDP

Answer 17

• Where injections= withdrawals
• In simple model where S+I
• In open economy where:
  S + T + IM= I + G + X

Question 18

How effectiveness of fiscal policy changes in an open economy?

Answer 18

Higher income from fiscal expansion leads to higher imports which are a withdrawal from the circular flow of income.

Question 19

Stabilization policy

Answer 19

Any policy that attempts to influence GDP through fiscal measures such as changes in taxes and gov spending.

Question 20

How to work out how much a AE component increase causes a change in equilibrium GDP?

Answer 20

= change in AE component x the multiplier

Question 21

What will changes in tax rates cause?

Answer 21

• 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.

Question 22

Factors that change the slope of the AE curve

Answer 22

• MPC and MPS
• Rate of income tax
• Propensity to import

Question 23

Balanced budget multiplier

Answer 23

= Change in GDP/ Change in gov spending that brought it about.

Question 24

How balanced budget multiplier works?

Answer 24

• 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.

Question 25

Deficit-financed

Answer 25

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.

Question 26

How monetary policy affects AE?

Answer 26

Through changes in the interest/bank rate and money supply.

Question 27

Relationship between the marginal propensity to import and marginal propensity to spend

Answer 27

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.