International Trade and Equilibrium Output Chapter 10 continued

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

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)

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

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

 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

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

See graph on page 188  Supports the generalizations

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

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

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

 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

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)

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

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

 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

 Determine the equilibrium GDP for the open economy.  Equilibrium GDP is $350b GDP = C + Ig + Xn  GDP =  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

 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 =  GDP = $300 billion

 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 =  GDP = $400 billion  The generalization  Increases in imports reduce GDP, decreases in imports increases GDP

 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.

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

CLASSWORK—10 minutes  Read Equilibrium Vs Full-employment GDP on pages  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