L7 - Net Exports, Equilibruim Income and Economic Policy Flashcards
What are Exports as part of the National Income Formula?
- Exports are goods and services made in the UK but sold abroad.
- Exports depend positively on the level of foreign income and negatively on the price competitiveness of foreign goods; i.e. as home prices rise relative to foreign prices the demand for exports falls
- Since both foreign income and foreign price competitiveness are largely exogenous, we assume here that exports, X, are exogenous
What are Imports as part of the National Income Formula?
- Imports are goods and services made abroad but purchased by UK residents
Imports rise with domestic income and rise with the price competitiveness of foreign goods; i.e. as home prices rise relative to foreign prices the demand for imports rises. - Since price competitiveness is largely exogenous, imports can be written as:
IM = m0 – mY, - where 0 < m < 1
- where m is the marginal propensity to import (mpm),
What is Net Exports as part of the National Income formula?
- Combining exports and imports we get the notion of desired net exports which can be written as:
- NX = X – m(0)– mY = x(0) – mY
where, as before, m is the marginal propensity to import and x(0) = (X – m(0)) captures the autonomous factors such as price competitiveness and foreign income - desired net exports are negatively related to GDP because of the positive relationship between desired imports and the assumption that exports are exogenous (as GDP goes up, so does income thus more imports therefore Net Exports goes down)
What do the Net Export Function look like on a graph?
- with Imports and Exports on the y-axis and Income (Y) on the x-axis
- a Horizontal line for Exports at y=X
- a diagonal line of Imports with the gradient of m and y intercept of m(0)
- the diagonal line of Net Exports with a negative gradient, with the gradient of -m and y intercept of x(0)
- when Exports intercepts Imports at Y(0) Net Exports is equal to 0
What are the important constant variable when drawing the Net Export function?
- The major variables that must stay constant are foreign GDP, relative international price levels and the exchange rate
What can cause shifts in the Net Export Function?
- Foreign GDP – a rise in foreign GDP causes the demand for exports to rise. This causes NX to shift upwards. Similarly a fall in foreign GDP cause NX to shift downwards
- 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
What are some examples of International Price Level changes that could shift the Net Export Function?
- Consider a rise in domestic prices relative to foreign prices: foreigners will see domestic goods as more expensive and hence home exports will fall. On the other hand, domestic residents will find foreign goods relatively cheaper and imports will increase and the NX schedule will shift downwards
- Suppose home and foreign prices are constant but the exchange rate of sterling depreciates – this makes imports more expensive and exports cheaper and the NX schedule will shift upwards
What is the Full Model of Equilibrium GDP?
AE = Y = C + I + G + NX
= a + b(Y –t(0) – tY) + I + G + x(0) – mY
= a – bt(0) + I + G + x(0) + [b(1 – t) – m]Y
Y[1– b(1 – t) + m] = a – bt(0) + I + G + x(0)
Y = (a – bt(0) + x(0) + I + G)/ [1– b(1 – t) + m]
What is the Full Model of Equilibrium GDP multiplier?
- Thus the full, open economy multiplier with government is:
- k(0) = 1/ [1– b(1 – t) + m]
This is smaller than the previous multipliers because m>0; so we have that: k > k(G) > k(O)
What does the Expenditure Income diagram look like for the Full model of Equilibrium GDP?
With Aggregate Expenditure (AE) on the y-axis and Income (Y) on the x-axis
- the 45 degree line of AE=Y
- the diagonal line of C+I+G+NX with the gradient of b(1-t)+m and the y intercept of (a – bt(0) + x(0) + I + G)
- Equilibrium GDP is determined when desired aggregate spending equals national output
How can the Savings Function be applied to the Full Model of Equilibrium GDP?
The national income equilibrium -Y = C+ I + G + NX -can also be identically -written as an equality between injections and withdrawals from the circular flow of income; i.e. -S + T + IM = I + G + X -Rearranging this identity gives S + (T – G) = I + (X – IM) where (T – G) is the budget surplus S + (T – G ) is total domestic savings I + (X – IM) is domestic asset formation (net increase in physical assets)
What is a way of balancing the Nation Income Formula?
- rearranging S+T+IM=I+G+X to (S-I)+(T-G)=(X-IM) - where (S-I) is the private saving balance - where (T-G) is the government balance - where (X-IM) foreign sector balance
How does the National Income formula look like on a graph with the Savings Function in it?
- With Saving & Asset Accumulation on the y-axis and Income (Y) on the x-axis
- the Diagonal Line S+(T-G) with gradient of 1-b+t and y intercept of -a+t(0)-G
- the Diagonal Line I+(X-IM) with the negative gradient of -m and y intercept of I+x(0)
- These both cross at Y(0) at the value of 0
- This is an equivalent equilibrium to AE=Y for the determination of equilibrium GDP is that injections (investments +government spending + exports) must equal leakages (savings + taxes + imports)
Why is the Effectiveness of Fiscal Policy in an Open Economy?
- In an open economy, the effectiveness of fiscal policy is reduced 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
- Thus the size of the trade balance deficit (or net exports) is often viewed as a constraint on expansionary fiscal polices, especially if the country is following a fixed exchange rate policy
- Although the deficit maybe be financed 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
What does the Current Account Balance (NX) against Net National Savings (S+T)-(I+G) look like on graph?
- With AE on the y-axis and Income (Y) on the x axis
- with the line (S+T)-(I+G) on a positive gradient
- with the line NX on a negative gradient
-If the lines intercept above the x-axis there is a budget surplus and below there is a budget deficit
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