Question

Question 2

Net export (NX =X-IM), where X is export and IM is import. Now assume that the proportion of additional income that is spent on import is 0.1, this is called the marginal propensity to import (mpim)). This is similar to the MPC.

Assume that import depends on income such that the total import is IM=0.1(Y) here 0.1 is mpim.

Let C=1000+0.5Y_d, I=300, G=200, T=100 and X=300. Y_d=Y-T+TR and TR=200. Note that T and TR represents Taxes and transfer payments, respectively.

Derive the Aggregate demand function

What is the equilibrium level of output, consumption?

Is the economy operating a trade surplus/deficit in equilibrium?

Answer 1

a) Derive the Aggregate demand function

AD = Y

C + I + G + NX = Y

1000 + 0.5*(Y - 100 + 200) + 300 + 200 + (300 - 0.1Y)

1850 + 0.4Y = Y

b) What is the equilibrium level of output, consumption?

1850 + 0.4Y = Y

1850 = Y - 0.4Y

Y* = 1850/0.6 = 3083.33

Consumption C = 1000 + 0.5*(3083.33 - 100 + 200) = 2591.665

c) Is the economy operating a trade surplus/deficit in equilibrium?

NX =  (300 - 0.1*3083.33) = -8.33.

SInce the NX are negative, there is a trade deficit in the equilibrium