L7 - Net Exports,Equilibrium Income and Economic Policy (HAS SOME STUFF ON EXCHANGE RATES TOO)

Question 1

What are Exports?

Answer 1

• Goods and services made in the UK but sold abroad
• Depend positively on the level of foreign income and negatively on the price competitiveness of foreign goods
• Both foreign income and foreign price competitiveness are largely exogenous, we assume here that exports, X, are exogenous

Question 2

What are Imports?

Answer 2

• Goods and services made abroad but purchased by UK residents
• Rise with domestic income and rise with the price competitiveness of foreign goods

Question 3

How can Imports be denoted?

Answer 3

IM = m0 – mY,
where 0 < m < 1

where m is the marginal propensity to import (mpm)

Question 4

How is Net Exports denoted as?

Answer 4

NX= X-IM

X-IM= X- m0 -mY
X- m0-mY= x0 - mY

DIAGRAM ON NOTES

Question 5

What causes shifts in the Net Export Function?

Answer 5

• Foreign GDP: rise in foreign GDP causes the demand for exports to rise. Causing NX to shift upwards
• Relative International Prices: Any change in the relative prices of home-produced goods relative to those of foreign goods will cause both imports and exports to change.

Question 6

What is the Total Multiplier including Govt. spending and NX?

Answer 6

1/[1-b(1-t)+m]

Smaller than previous multiplier as M is greater tha 0 leading to lower AE

Question 7

How can the National Income equilibrium be rewritten as a equality between injections and withdrawals from the circular flow of income?

Answer 7

Circular Flow of Income:
S+ T+IM= I + G + X

National Income Equilibrium:
Y= C+I+G+NX

Rearranging:
S+(T-G)=I+(X-IM)

Where:
(T-G) is budget surplus
S+(T-G) is total domestic savings
I+(X-IM) domestic asset formation

DIAGRAM FOR DOMESTIC SAVINGS AND NATIONAL INVESTMENT IN NOTES

Question 8

What do changes in elements of Fiscal Policy reflect or lead to?

Answer 8

• Changes in autonomous taxes or Govt spending lead to parallel shift in domestic saving function
• Changes in marginal tax rate reflected by changes in slope of domestic savings function

Question 9

Why is the effectiveness of Fiscal Policy reduced in an open economy?

Answer 9

Because the higher income from the fiscal expansion leads to higher imports (lower net exports) which are a withdrawal from the circular flow of income

Question 10

How can a deficit be financed?

Answer 10

By borrowing from abroad in the short run, this cannot continue forever, and either the country will be forced to devalue the currency or reverse the fiscal expansion

SHOWN IN DIAGRAM

Question 11

Why is the size of the trade balance deficit viewed as a constraint?

Answer 11

Often viewed as a constraint on expansionary fiscal policies, especially if the country is following a fixed exchange rate policy

Question 12

What is the Tinbergen Principle

Answer 12

Two targets of policy needs two policy instruments

SHOWN IN DIAGRAM ABOUT DEFICIT

Question 13

What is Real Exchange Rate also known as?

Answer 13

Competitiveness

Question 14

How is the Real Exchange Rate calculated?

Answer 14

EP*/P

Where E is nominal exchange rate (£/$)

P* is foreign price in $

P is domestic price in £

Question 15

When and How does a country get more competitive?

Answer 15

• If E and P* fixed and P goes up: Then Competitiveness decreases and Real Exchange Rate decreases
• If E goes down but P and P* fixed: Our currency appreciated but dollars depreciated= Competitiveness down

Question 16

When does Devaluation occur?

Answer 16

Devaluation occurs if E goes up: (under assumptions of ceteris paribus)

• Meaning exports become cheaper
• UK competitiveness Increases
• E increases, IM down replace foreign goods with domestic goods

Question 17

What is it called when you devalue your currency?

Answer 17

Expenditure Switching Policy

Question 18

What is it called when you increase govt policy spending?

Answer 18

Expenditure Increasing Policy