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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