Question

"Imports act as an automatic stabilizer in an open economy."
Is this statement correct? Explain your answer.

Answer 1

Answer: This statement is correct.

At equilibrium, Aggregate expenditure = Y = C+I+G+(X-M). In open economy, M i.e. import is a function of Y.

C = a+bY, M = c+dY, I,G and X are constant. Then value of multiplier = (1/1-b+d).

If any of the autonomous expenditures is changed to change the output, the marginal propensity to import acts as stabilizer. Without import, the value of multiplier would be (1/1-b) which is greater than value of multiplier with import i.e. (1/1-b+d). Thus import reduces the impact of change in, say, government expenditure and tries to take the economy back to original level of output.