Question

Explain the difference between the following two expressions:

Y = C(Y^d) + I + G +CA(EP*/P, Y^d) and Y = C+ I + G + CA

Answer 1

The second expression on the right shows that the national output depends on the consumption spending, investment and government spending and the currenct account balance. The expression on the left shows that the national output depends on consumption but here consumption depends on disposable income which is income after tax. The investment given by the equation on the left is still autonomous and so is the level of government spending. The current account balance in the equation on the left is however not autonomous, it now depends on the real exchange rate and also on the level of dispoable income. The real exchange rate adjusted for inflation and the disposable income both effects the current account balance in the equation on the left. While this is not the case on the right.