We assume that exports(X) are exogenous--that is,

1
Incomeexpenditure analysis for an open economy
We assume that exports(X) are exogenous--that
is, determined by macroeconomic conditions abroad
Let X
X
X
X is invariant wrt Y
0
Y
2
Impact of Asian Crisis
Deteriorating performancein Asia, combined
withdepreciating currencies,weakens the demand
for U.S.-made goods.
X
100
X1
80
0
Y
3
Imports are endogenous

• Let
• where
• is exogenous imports and
• m is the marginal propensity to import
• m ?M/?Y, where0lt m lt1

M
M 50 .05Y
75
50
0
Y
500
4
Algebraic determination of equilibrium income
--the open model
Y ? C I G (X - M) (1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Substitute (5) and (6) into (2), and rearrange to
obtain
(9)
5
Now substitute (9), (3), (4), (7), and (8) into
(1)
(10)
(11)
Notice that you have the components of exogenous
spending isolated on the right-hand side of
equation (11). Thus we can write
(12)
To solve for equilibrium national income (Y0)
Open economy multiplier
6
The income-expenditure diagram
AD
AD Y
?
450
Y
Y0
0
7
Now we model the effects of a ballooning current
account deficit on domestic output (and
employment)
We will assume that an increase in the trade
deficit comes about as a result of an increase in
exogenous imports (M), a decrease in exogenous
exports (X), or both. Recall equation (12)
(12)
Thus, a trade deficit means a decrease in A
8
AD2
AD1
450
0
9
Problem
Use the set-up below to answer the questions on
the following slide
Y ? C I G (X M)
C 75 .8YDI 110G 180X 40M 15
.04YTR 250TA .2Y
10

1. Calculate the value of the open economy
   multiplier.
2. Calculate the value of equilibrium GDP (Y0).
3. Calculate the value of disposable income (YD)
   when GDP assume the value you computed in (2)
   above.
4. Calculate the change in imports (?M) resulting
   from a 20 decrease in exogenous investment (
   ).
5. Assuming the economy is in equilibrium as you
   calculated in (2) above, illustrate the effects
   of a 10 increase in exports, ceeteris
   paribusthat is
6. Suppose the full-employment value of GDP (YF) is
   equal to 1,575 (and assuming the economy is in
   equilibrium as you calculated in (2) above). What
   change in government expenditure would be
   required to achieve a full-employment equilibrium?