1. 1 Variable Net Exports and Algebra of Income and Expenditure CHAPTER 25 Appendixes A and B © 2003 South-Western/Thomson Learning

2. 2 Variable Net Exports A more realistic approach has net exports varying inversely with income The effect of looking at this option is provided in Exhibit 7

3. 3 Exhibit 7: Net Exports and Aggregate Expenditures X – M Real GDP (trillions of dollars) 0 (a) Variable net-export function 5.06.07.08.010.011.012.09.0 C + I + G C + I + G + (X – M) (b) Aggregate expenditure lines 5.006.07.08.09.010.011.012.0 Real GDP (trillions of dollars) Aggregate expenditure (trillions of dollars Net exports (trillions of dollars) Panel (a) presents the net export function assuming that net exports vary inversely with income. Panel (b) shows what happens when variable net exports are added to the other components of aggregate expenditure. Because variable net exports and real GDP are inversely related, the addition of variable net exports has the effect of flattening out, or reducing the slope of the aggregate expenditure line.

4. 4 Net Exports and the Multiplier Inclusion of variable net exports implies that the formula for the multiplier must be altered to include the marginal propensity to import, MPM MPM is the fraction of each additional dollar of disposable income that is spent on imported goods Spending multiplier = 1 / (MPS + MPM)

5. 5 Algebra of Income and Expenditure Real GDP demanded for a given price level occurs where planned spending equals income Algebraically this equality can be written as Y = C + I + G + (X – M)

6. 6 Consumption Because consumption depends on disposable income, the general form of the consumption function can be written as C = a + b(Y – NT), or C = a – bNT + bY Where a – bNT is autonomous consumption (the portion of consumption that is independent of the level of income) and bY is induced consumption, e.g., that portion of consumption generated by the level of income in the economy

7. 7 General Model Recall that income must equal output, therefore Y = a – bNT + bY + I + G + (X – M) Which can be rearranged to yield Where a – bNT + I + G + X – M is autonomous spending And (1 / 1 – b) is the simple multiplier

8. 8 Variable Net Exports If we now add variable net exports, this equation would become Y = a + b(Y – NT) + I + G + X – m(Y – NT) which yields the following equilibrium equation