income determination international dimension. overview nkeynesian income determination models u...
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Income DeterminationInternational Dimension
Overview Keynesian Income Determination Models
Private sector Consumption demand Investment Demand Supply & demand for money
Public Sector Government expenditure Government taxes Monetary policy manipulation of money supply
International imports, exports, net exports
International Trade
Imports (M) goods and services purchased from foreigners money spent here is subtracted from aggregate demand we often assume M = mY, or M = l + mY
(where m = marginal propensity to import)
Exports (X) addition to aggregate demand
Trade Balance - I
Balance of Payments all inflows and outflows transactions that bring in foreign exchange = credits transactions that lose foreign exchange = debits
BofP includes Current account Capital account
Trade Balance - II
Current Account Imports & Exports of goods and services Income received or paid on investments
Trade Balance Exports of goods and services minus imports X - M
Trade "deficit" = M > X Trade “surplus” = M < X
New identity
YC + I + G + X - M Y C + I + G + (X - M) where (X - M) = net X's Y C + I + G + (X - [l + mY])
Y C + I +G + (X - M) Equilibrium when planned expenditures = actual
expenditures, or aggregate demand, C + I + G + (X - M) = aggregate output (Y).
C + I + G
C+I + G + (X - M) w/(X>M)
Y
C, I, G, X, M
Ye
Y C + I + G + (X - [l + mY])
Suppose we assume imports rise with rising income
Y
C, I
Ye
w/(M = M)
w/(M = l + mY)
Algebraic Solutions
Y C + I + G where C = a + bY where I = I, or I = f + gY where G = G where M = M, or
M = l + mY Solve for equilibrium Y
S I + G + (X - M) where S = -a + (1-b)Y where I = I, or I = f + gY where G = G where M = M, or
M = l + mY Solve for equilibrium Y
Problems
What will be the effect on Y of an increase in imports?
What will be the effect on Y of an increase in exports?
What will be the effects of a trade deficit? What of a trade surplus?
Open Economy Multiplier - I Y C + I + G Ya + bY -bT + I + G + (X - [l + mY]) Y = a/(1 - b + m) -bT/(1 - b + m) + I/(1 - b + m) +
G/(1 - b + m)+ X/(1 - b + m) - l/(1 - b + m) We can solve for any multiplier by taking the
derivative, in the process of which all values on right = 0 except for for those with the variable
e.g., dY/dG = 1/(1 - b + m) = government expenditure multiplier
Open Economy Multiplier - II In dY/dG = 1/(1 - b + m) we see multiplier is
LOWERED by imports A given increase in G (or I, or X) will have LESS
of an impact on Y because some of the increase in Y is spent abroad
Trade Feedback Effect
trade feedback effect = "tendency for an increased in the economic activity of one country to lead to a world wide increase in economic activity"
E.g., US Y M = X of other countries Y in those countries
This in foreign Y US X's US Y
Homework
Suppose you followed the kind of policies used by the American administration in 1972, cutting back agricultural production & expanding exports, raising exports by 10%. What would be effect on aggregate Y? On trade balance?
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