L8._Net_Exports__Equilibrium_Income_and_Economic_Policy

Page 1: Introduction

Topic Overview: This module explores the intricacies of Economic Fluctuations and Unemployment, emphasizing the roles of Net Exports, Equilibrium Income, and Economic Policy in shaping economic landscapes. Understanding these concepts is crucial for grasping how international trade influences national economies.Instructor: Dr. Ahmad Hassan, a specialist in economic policy at the School of Business & Economics, Loughborough University.Contact Information: Room 2.09, Sir Richard Morris Building, Email: A.H.Ahmad@lboro.ac.uk, Phone: (01509) 222 719.Consultation Hours: Monday 14:00 – 15:30 (In Person), Thursday 14:00 – 15:00 (Via MS Teams).

Page 2: Reading Materials and Structure

Reading Lists:

• L&C chapters 16-17 from Economics by Begg et al. provide foundational knowledge on macroeconomic principles.

• Chapters 17-18 from Principles of Economics by McDowell et al. cover critical analytical frameworks relevant to income models.

• Latest data from the ONS UK economy available at the Office for National Statistics offers real-world insights and statistical backing for theoretical concepts.

Page 3: Lecture Goals

Focus: The integration of exports and imports into the model of income determination to understand how trade balances influence overall economic performance.Significance: Notably, exports and imports account for approximately 25% of the UK GDP as of 2013, highlighting their importance in economic activity.Objective: Engage in a discourse on the impacts of fiscal and monetary policies on the balance of trade, emphasizing their role in addressing trade deficits and promoting economic stability.

Page 4: Understanding Exports (X)

Definition: Exports refer to goods and services produced within the UK and sold in international markets, contributing to national income.Determinants:

• They are positively correlated with foreign income levels, meaning that as foreign economies grow, the demand for UK exports typically increases.

• Conversely, they are negatively correlated with the price competitiveness of foreign goods. As UK prices rise due to inflation or increased production costs, demand for UK exports can decline.Assumption: The analysis assumes that exports are treated as exogenous factors, influenced by external variables rather than domestic economic conditions alone.

Page 5: Understanding Imports (IM)

Definition: Imports are defined as goods and services that are produced abroad and purchased by residents of the UK, which can impact domestic production and consumption patterns.Influences:

• Import levels rise with increases in domestic income, as higher income levels generally lead to greater consumption of foreign goods.

• They also rise with the price competitiveness of foreign goods, whereby increases in UK prices attract more imports due to relative affordability.Model Representation: The import function can be expressed as IM = m0 + mY, where m represents the marginal propensity to import (mpm), indicating that imports increase with income (0 < m < 1).

Page 6: Net Exports (NX) Calculation

Formula: Net Exports can be calculated as NX = X - m0 -mY, which can be rearranged to show that NX = x0 - mY. This manifests as NX = X + m0 + mY, where x0 = (X - m0), encapsulating key factors such as foreign income and price competitiveness that drive export variation.

Page 7: Economic Model Diagram

Graphical Representation: This section includes a graphical representation of Net Exports plotted against various levels of income, illustrating how income changes can impact both exports and imports. Such visual models help deepen the understanding of these economic relationships.

Page 8: Shifts in Net Export Function

Influences on NX:

• Generating economic growth portrayed as a rise in foreign GDP typically causes Net Exports to shift upwards due to increased export potential.

• Conversely, a decrease in GDP results in downward adjustments in NX.

• Additionally, fluctuations in relative international prices can significantly impact both imports and exports, demonstrating the fluidity of global trade dynamics.

Page 9: Price Comparison Effects

Impact of Domestic Price Increase: When domestic prices escalate relative to foreign counterparts, this typically leads to a dual effect: a decrease in exports and an increase in imports, resulting in a net downshift of the NX schedule.Exchange Rate Effects: Depreciation of the exchange rate can render domestic goods more affordable to international buyers, often leading to an upshift in Net Exports as exports increase.

Page 10: Full Equilibrium Model

Equilibrium GDP Expression:The model can be succinctly expressed as AE = Y = C + I + G + NX = a + b(Y - t0 - tY) + I + G + x0 + mY.By factoring out Y, we delve into solving for equilibrium GDP.The resulting formula facilitates clearing for Y = (a + bt0 + x0 + I + G) / [1 - b(1 - t) + m], establishing the relationship between aggregate expenditure and income levels.

Page 11: Open Economy Multiplier

Expression: The open economy multiplier can be expressed as ko = 1/[1 - b(1 - t) + m], demonstrating the multiplicative effects of fiscal policy in an open economy context.Comparison: k < kG > kO, indicating that the government spending multiplier typically exceeds the open economy multiplier, affecting fiscal planning strategies.

Page 12: Income-Expenditure Diagram

Illustration: A corresponding graph illustrates the aggregate expenditure compared to income, providing visual insights that assist in modeling fiscal policy implications and their outcomes on economic activities.

Page 13: Alternative Approach to National Income

National Income Equilibrium Formula Representation:The equilibrium can also be understood through the formula Y = C + I + G + NX, which correlates injections (I and X) against withdrawals (S and T - G) in the circular flow of income.Rearranging this yields: S + (T - G) = I + (X - M), portraying the importance of balancing savings and investments in the economy.

Page 14: Savings and Investment Model

Diagram Overview: A diagram illustrating the correlation between total domestic savings (S + T - G) and national investment formation provides a structural framework for analyzing fiscal health.

Page 15: Model Continuation

Note on Diagram: Continues to depict the equilibrium level Y0 as previously discussed, enriching the understanding of equilibrium dynamics.

Page 16: Fiscal Policy Dynamics

Impact on Saving Functions: Changes in autonomous taxes or government spending directly shift domestic saving functions. Additionally, varying tax rates can alter the slope of the savings function, affecting overall economic balances and influencing consumption habits within the economy.

Page 17: Trade Deficit Implications

Challenge for Fiscal Policy: Trade deficits pose challenges for fiscal expansion strategies, necessitating careful adjustments to maintain economic stability. Understanding the current account balance, which involves the interaction of Net Exports with national savings (S + T) and investment demand (I + G), is integral for policymakers.

Page 18: Visualization of Fiscal Policy Impact

Graphical Representation: This visual representation graphically displays the dependence of Net Exports on national savings and fiscal policies, illustrating the complex interaction of different economic components.

Page 19: Combining Fiscal and Exchange Rate Policies

Mitigating External Deficits: Recommendations may include currency devaluation as a countermeasure against adverse fiscal expansion effects on trade balances, necessitating a careful consideration of domestic economic capacity prior to policy implementation.

Page 20: Effective Policy Combination

Aligning Fiscal Policy and Economic Capacity: Strategically achieving internal and external equilibrium may involve smaller currency devaluations in conjunction with fiscal expansions, showcasing the delicate balance needed in economic policy formulation.Tinbergen Principle: This economic principle asserts that achieving simultaneous economic objectives (internal and external balance) may require two separate policy instruments, underlining the importance of versatile fiscal strategies.

Page 21: Summary and Limitations

Key Takeaways: Alterations in elements of aggregate spending can substantially influence equilibrium GDP via multipliers. Multi-targeted policies necessitate the application of unique instruments in accordance with the Tinbergen principle, emphasizing the complexity and interplay in economic policymaking.This model currently operates under fixed price assumptions, awaiting further enhancements from supply-side economics research that invites new perspectives on economic dynamics.