International Trade and Equilibrium Output

1. International Trade and Equilibrium Output Chapter 10 continued

2. GDPs • Equilibrium GDP for a closed economy= • GDP = C + Ig • Equilibrium GDP for an open economy without gov’t involvement = • GDP = C + Ig + Xn • Equilibrium GDP for an open economy with gov’t involvement = • GDP = C + Ig + G + Xn

3. Net Exports • Export – imports • Exports expand aggregate expenditure • Exports (X) create domestic production, income & employment due to foreign spending on US produced g & s • Imports contract aggregate expenditure • Imports (M) reduce the sum of C & Ig expenditures by the amount expended on imported goods (so this amount must be subtracted so that spending on US produced goods is not overstated)

4. Net Exports & Equilibrium GDP • POSITIVE NET EXPORTS • Multiplier effect • A positive Xn leads to a positive change in equilibrium GDP • See table 9.4 on page 173 • Suppose Xn is +5 billion for each level • GDP equilibrium = C + Ig + Xn • Where is the new equilibrium GDP? • 490 • A 5b increase in Xn = 20b in GDP—what is the multiplier? • 4

5. Generalization (page 187 in text) • Other things equal, positive net exports increase aggregate expenditures and GDP beyond what they would be in a closed economy

6. NEGATIVE NET EXPORTS • Multiplier effect • A negative Xn leads to a negative change in equilibrium GDP • See table 9.4 on page 173 • Suppose Xn is -5 billion for each level • GDP equilibrium = C + Ig + Xn • Where is the new equilibrium GDP? • 450 • A 5b decrease in Xn = 20b decrease in GDP—what is the multiplier? • 4

7. Generalization (page 187 in text) • All things equal, negative net exports reduce aggregate expenditures and GDP below what they would be in a closed economy

8. See graph on page 188 • Supports the generalizations

9. Government Spending • An increase in gov’t spending boosts aggregate expenditure • See the table on page 190 and graph on page 191 • Gov’t spending is 20 billion at every level • The new equilibrium is 550 • GDP = C (510) + Ig (20) + Xn (0) + G (20) • Remember that GDP was 470 when it was only C + Ig

10. The sum of leakages (savings, imports and taxes) = sum of injections (investment, exports and G purchases) at the equilibrium GDP

11. International Economic Linkages • Prosperity Abroad • Higher incomes of trading partners allows the US to sell more goods, raising the Xn and increasing GDP • Recession abroad causes the reverse effect

12. Exchange Rates • Depreciation of the dollar lowers the cost of American goods to foreigners and encourages exports from the US while discouraging the purchases of imports in the US • If economy is operating below full-employment, a rise in Xn will increase expenditure and expand GDP • If economy is at full-employment, an increase in Xn & expenditure will cause demand-pull inflation

13. HOMEWORK!! Due Tomorrow • Page 201 • Number 4 • Number 5 • Number 6 (read the tax section on your own) • Number 7 (use figures 10-5 and 10-6 for help)

14. Number 4 • Suppose that Zumo has an MPC of .9 and real GDP of $400 billion. If investment spending falls by $4 billion, what will be its new level of real GDP? • The multiplier is 10 or 1/(1-.9) so 10 X-$4 billion = -$40 billion. The new GDP is $400 billion - $40 billion = $360 billion

15. Number 5 • QA. Use columns 1 and 2 to determine the equilibrium GDP for this hypotheticaleconomy • A. Equilibrium GDP for closed economy is $400 billion (GDP = C + Ig)

16. QB. The economy is now open for international trade by including the export and import figures of columns 3 and 4. Calculate net exports • B. Net export data for column 5 is $-10 in each case (X – M). Aggregate expenditure data for column 6 (top to bottom) – subtract Xn from C + Ig • 230 270 310 350 390 430 470 510

17. Determine the equilibrium GDP for the open economy. • Equilibrium GDP is $350b • GDP = C + Ig + Xn • GDP = 360 + -10 • Explain why equilibrium GDP differs from the closed economy. • $50b below the $400b equilibrium for the closed economy. The $-10 billion of net exports is a leakage which reduces equilibrium GDP by $50 billion

18. QC. Given the original $20b level of exports, what would be the equilibrium GDP if imports were $10b greater at each level of GDP • C. Imports = $40 billion (30 +10) • the new equilibrium GDP would be $300 billion. (GDP = C + Ig +Xn) • GDP = 320 + -20 • GDP = $300 billion

19. QC Or at a billion less at each level of GDP • Imports = $20 billion (30 – 10): the new equilibrium GDP would be 400 billion. • (GDP = C + Ig +Xn) • GDP = 400 + 0 • GDP = $400 billion • The generalization • Increases in imports reduce GDP, decreases in imports increases GDP

20. QD. What is the multiplier in these examples? • D. Since every rise of $50 billion in GDP increases aggregate expenditure by $40 billion, the MPC is .8 and so the multiplier is 5.

21. Number 6 • QA. Graph this consumption schedule and not the size of the MPC. • A. The size of the MPC is 80/100or .8 because consumption changes by 80 when GDP changes by 100. • QB • A. The resulting C schedule will be exactly $10B below the original at all levels of GDP because people now have to pay $10B in tax out of each level of income. The multiplier should be 5 because the MPS is .2 and 1/.2 is 5. • Equilibrium decreases

22. CLASSWORK—10 minutes • Read Equilibrium Vs Full-employment GDP on pages 194-195. • Select one of the following: • The Great Depression in the US (p. 196) • Vietnam War (p. 197) • The End of the Japanese Growth “Miracle” (p. 197) • Take Notes (at least 3) on how the ideas of recessionary or inflationary gaps apply to the event