increase in domestic demand – assume increase in gov’t spending (G)
- shifts demand up by DG
- output increases by more than DG due to multiplier effect
- but not as much as it would’ve increased in a closed economy
- multiplier = 1 / (1-c-m-d)
- d = marginal propensity to investment
- m = marginal propensity to import
- c = marginal propensity to consume
- trade deficit increases
- net exports doesn't change
- NX
- note that changes in output also affect the trade balance (since imports dependent on Y and both exports/imports)
increase in foreign demand – assume increase in foreign output (Y*)
- exports increase >> demand shifts up by the increase in exports
- output increases
- net exports also increases >> trade balance improves (possible trade surplus)
- net exports line shifts up
- countries don’t want to use gov’t spending to increase own domestic demand
- would create a trade deficit >> have to pay yearly interest
- prefer foreign demand increase to domestic demand increase
coordination – no deficits if all countries increased demand together
- may force some countries to do more than others
- different situations in each country makes it difficult to agree on single action
- free-rider incentive >> countries would rather promise coordination and not follow through
- can reap the benefits w/o doing any work, making sacrifices
Subject:
Subject X2:
