7.2 Introducing Foreign Trade

Question 1

Roughly how many goods and services are imported/exported to and from Canada per year?

Answer 1

Of all the goods and services produced in Canada in a given year, roughly a third are exported. A similar value of goods and services is imported into Canada every year.

Question 2

What is an important distiction to remember about AE?

Answer 2

Recall that AE is desired expenditures on domestically produced goods and services.

Question 3

How do exports and imports affect total expenditures that determine AE?

Answer 3

Exports are purchases by foreigners of Canadian products and so are a component of AE. In contrast, imports are expenditures by Canadians on goods and services produced elsewhere and thus must be subtracted from total expenditures to determine AE. It is therefore net exports (X - IM) that appears in our macro model as part of AE.

Question 4

Why do we treat exports as an autonomous expenditure?

Answer 4

Exports depend on spending decisions made by foreign households and firms that purchase Canadian products. Typically, Canada’s exports will not change as a result of changes in Canadian national income. We therefore treat exports, X, as autonomous expenditure.

Question 5

Why do we get a positive relationship between imports and national income (GDP)?

Answer 5

Because consumption rises with national income, we also get a positive relationship between imports and national income (GDP).

Question 6

In our macro model, we use the following simple form for desired imports:

Answer 6

Question 7

What is the definition of The Marginal Propensity to Import?

Answer 7

Marginal propensity to import

      The increase in import expenditures induced by a $1 increase in national income. Denoted by m.

Question 8

In our model, net exports can be described by the following equation:

Answer 8

Question 9

Why are net exports negativly related to national income?

Answer 9

Since exports are autonomous with respect to Y but imports are positively related to Y, we see that net exports are negatively related to national income. This negative relationship is called the net export function.

Question 10

What happens to Net exports as national incoem rises?

Answer 10

Net exports fall as national income rises

Question 11

What happens to desired imports when national income rises?

Answer 11

Since desired imports rise when national income rises, net exports are inversely related to national income.

Question 12

Under what assumption is any given net export function drawn?

Answer 12

Any given net export function is drawn under the assumption that everything affecting net exports, except domestic national income, remains constant.

Question 13

What two major influences are held constant when we the draw the NX function?

Answer 13

The two major influences that are held constant when we draw the NX function are foreign national income and international relative prices. If either one changes, the NX function will shift.

Question 14

What will cause the NX funmction to shift parallel to itself?

Answer 14

Notice that anything affecting Canadian exports will shift the NX function parallel to itself, upward if exports increase and downward if exports decrease.

Question 15

What will chang the slope of the NX function?

Answer 15

Also notice that anything affecting the marginal propensity to import will change the slope of the NX function.

Question 16

How will an increasei n foreign income, other things being equal, effect the NX function?

Answer 16

An increase in foreign income, other things being equal, will lead to an increase in the quantity of Canadian products demanded by foreign countries—that is, to an increase in Canadian exports. This change causes the X curve in part (i) of Figure 7-1 to shift upward and therefore the NX function also to shift upward, parallel to its original position. A fall in foreign income leads to a reduction in Canadian exports and thus to a parallel downward shift in the NX function.

Question 17

How do booms and sumpts in the US usually effect Canada’s exports?

Answer 17

Booms in the United States generally lead to increases in Canadian exports; economic slumps in the United States usually lead to a slowdown in Canada’s exports. Through this trade “linkage,” economic conditions in the two countries are connected.

Question 18

What is an important determinant of Canada’s exports?

Answer 18

Changes in foreign GDP, especially in the United States, are an important determinant of Canada’s exports.

Question 19

How does the change of prices in canadian products relative to the prices of foreign products change the NX function?

Answer 19

Any change in the prices of Canadian products relative to the prices of foreign products will cause both imports and exports to change. These changes will shift the NX function.

Question 20

How will a rise in Canadian prices affect the X curve?

Answer 20

Consider what happens with a rise in Canadian prices relative to those in foreign countries. The increase in Canadian prices means that foreigners now see Canadian goods as more expensive relative both to goods produced in their own country and to goods imported from countries other than Canada. As a result, foreigners will purchase fewer Canadian products and so the value of Canadian exports will fall.1 The X curve shifts down

Question 21

How willl a rise in Canadian prices affect the marginal propensity to import and the IM curve?

Answer 21

Canadians will see imports from foreign countries become cheaper relative to the prices of Canadian-made goods. As a result, they will shift their expenditures toward foreign goods and away from Canadian goods. That is, the marginal propensity to import (m) will rise, and so the IM curve will rotate up.

Question 22

Changes in international relative prices shift the…

Answer 22

Question 23

How does a rise and fall in Canadian prices, relative to other coutries, effect national income?

Answer 23

A rise in Canadian prices relative to those in other countries reduces Canadian net exports at any level of national income. A fall in Canadian prices increases net exports at any level of national income.

Question 24

What is the most important cause of a change in international relative prices?

Answer 24

The most important cause of a change in international relative prices is a change in the exchange rate. A depreciation of the Canadian dollar means that foreigners must pay less of their money to buy one Canadian dollar, and Canadian residents must pay more Canadian dollars to buy a unit of any foreign currency. As a result, the price of foreign goods in terms of Canadian dollars rises, and the price of Canadian goods in terms of foreign currency falls.

Question 25

What happens as the price of foreign goods in terms of Canadian dollars rise?

Answer 25

As a result, the price of foreign goods in terms of Canadian dollars rises, and the price of Canadian goods in terms of foreign currency falls. This reduction in the relative price of Canadian goods will cause a shift in expenditure away from foreign goods and toward Canadian goods. Canadian residents will import less at each level of Canadian national income, and foreigners will buy more Canadian exports. The net export function shifts upward and becomes flatter.

Question 26

In our macro model so far, how do we treat prices and exchange rates?

Answer 26

It is important to keep in mind that our macro model so far treats prices and exchange rates as exogenous variables. That is, though we can discuss what happens if they change, we do not yet explain where these changes come from.

Question 27

Reason one that foreign trade modifies our basic model…

Answer 27

Foreign firms and households purchase Canadian-made products. Changes in foreign income and international relative prices will affect Canadian exports (X), but we assume that X is autonomous with respect to Canadian national income. When we construct the economy’s AE function, we will include X since it represents expenditure on domestically produced goods and services.

Question 28

Reason 2 that forign treade modifies our basic model…

Answer 28

All components of domestic expenditure include some import content. We assume in our model that desired imports rise when national income rises. When we construct the economy’s AE function, which shows the desired aggregate expenditure on domestic products, we will subtract IM because these expenditures are on foreign products.

Question 29

Is NX postively or negativly related to national income?

Answer 29

Question 30

Why is the net export function downward sloping?

Answer 30

The net export function is downward sloping because increases in real national income lead to increases in imports​ (IM) but leave exports​ (X) unchanged. Thus X - IM falls as real national income rises

Question 31

How is the marginal propensity to import related to the level of net exports at each level of income?

Answer 31

The higher the MPI, the lower the level of net exports

Question 32

Is the NX function positivly or negativly sloped?

Answer 32

Negativly

Question 33

What direction does an increase in forign income shift the NX curve?

Question 34

Answer 34

Find the answer