Understanding Foreign Trade: Impact on the Open Economy
This overview addresses the dynamics of foreign trade in an open economy, contrasting it with a closed economy. It defines key concepts like imports (IM) and exports (X) and examines how changes in domestic income (Y) influence trade. As consumer spending rises, the demand for foreign goods increases, indicating that imports act as a leakage in the domestic economy. Conversely, exports remain unaffected by domestic economic fluctuations, showcasing the complex interplay between domestic and international markets.
Understanding Foreign Trade: Impact on the Open Economy
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Presentation Transcript
Foreign Trade Holmes Econ 10
Open Economy • One of our assumptions was a closed economy • A nontrivial portion of of our economy is in fact due to foreign trade
Definitions Imports (IM): value of goods produced in other countries that are sold in the home country (US, say) Exports (X): value of goods produced in the the US and sold in other countries Imports come IMto the country (sorry)
Specifications How many more Toyotas would be sold in the US if Y increased dramatically? A: A few How many more Fords would be sold in China if Y increased? A: none. Do the Chinese care how well we do?
Specifications Imports are one type of good that consumers can choose from. Thus, as Y increase, IM should increase. But Exports have no tie to domestic Y. Thus, Y should not affect X.
Y and D How are these affected? What happens every time someone buys a Spice Girls CD? The portion of C that is spent on foreign goods must be subtracted out. That is, imports are a leakage from the D stream. Likewise, every time someone buys a Ford, the demand for US goods and services increases. Thus, D=C+I+G+X-IM Thus, MPS = MPC + MPI - MPIM
Problem Suppose Savings falls by 20 and we start sending 20 more dollars in Cowboy hats to Japan Find: Mult Change in Y Effect on trade deficit
