We assume that exports(X) are exogenous--that is, determined by macroeconomic conditions abroad Let X = X Y 0 X X is invariant wrt Y Income–expenditure.

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Presentation transcript:

We assume that exports(X) are exogenous--that is, determined by macroeconomic conditions abroad Let X = X Y 0 X X is invariant wrt Y Income–expenditure analysis for an open economy

Deteriorating performance in Asia, combined with depreciating currencies, weakens the demand for U.S.-made goods. X Y 0 X1X

M Y M = Y Imports are endogenous Let: where: is exogenous imports; and m is the marginal propensity to import m =  M/  Y, where 0< m <1

Y  C + I + G + (X - M) (1) (2) (4) (5) (6) (7) (3) (8) Substitute (5) and (6) into (2), and rearrange to obtain: (9)

Now substitute (9), (3), (4), (7), and (8) into (1): (10) (11) Notice that you have the components of exogenous spending isolated on the right-hand side of equation (11). Thus we can write: (12) To solve for equilibrium national income (Y 0 ) : Open economy multiplier

AD Y Y0Y0 0  AD = Y The income-expenditure diagram 45 0

Now we model the effects of a ballooning current account deficit on domestic output (and employment) We will assume that an increase in the trade deficit comes about as a result of an increase in exogenous imports (M), a decrease in exogenous exports (X), or both. Recall equation (12): (12) Thus, a trade deficit means a decrease in A

AD 2 AD

Y  C + I + G + (X – M) C = YD I = 110 G = 180 X = 40 M = Y TR = 250 TA =.2Y Use the set-up below to answer the questions on the following slide

1.Calculate the value of the open economy multiplier. 2.Calculate the value of equilibrium GDP (Y 0 ). 3.Calculate the value of disposable income (YD) when GDP assume the value you computed in (2) above. 4.Calculate the change in imports (  M) resulting from a $20 decrease in exogenous investment ( ). 5.Assuming the economy is in equilibrium as you calculated in (2) above, illustrate the effects of a $10 increase in exports, ceeteris paribus—that is 6.Suppose the full-employment value of GDP (Y F ) is equal to $1,575 (and assuming the economy is in equilibrium as you calculated in (2) above). What change in government expenditure would be required to achieve a full-employment equilibrium?