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The Multiplier - Suppose the dollar depreciates The dollar...

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The Multiplier The simple multiplier is equal to 1 divided by the marginal propensity to save or 1/ s . Suppose m is the marginal propensity to import. Then the spending multiplier in a small, open economy equal 1/( s + m ). This formula assumes that our imports have no effect on foreign economies. For a large open economy this is unlikely to be the case. The spending multiplier with foreign repercussions is [1 + ( m f / s f )]/[ s + m + (m f s/s f )] Effects of AD and AS on the Trade Balance 1. an increase in C + I + G will likely worsen the trade balance as imports will rise more than exports 2. an increase in exports will improve the trade balance 3. an increase in AS will lower prices and improve the trade balance as we export more and import less Effects of Devaluation on National Income Suppose the U.S. exports aircraft and imports shoes. U.S. net exports would be equal to Price in $ aircraft x Quantity of Aircraft Exported - Price in $ shoes x Quantity of Shoes Imported
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Unformatted text preview: Suppose the dollar depreciates. The dollar price of shoes rises for American buyers while the price of aircraft falls for foreign buyers. Shoe imports fall and aircraft exports rise. However, since imports have become more expansive, their real value may rise even though the quantity of imports falls. If the change in the exchange rate causes a large change in the quantity of imports and exports, then net exports will rise. Typically, in the short run the quantity of imports and exports does not change much. So, net exports fall. After consumers and firms have had time to adjust their spending patterns, net exports will rise. Generally, the exchange rate and the trade balance move in opposite directions. So, a devaluation will cause national income to rise if 1. devaluation actually improve the trade balance 2. the terms of trade do not worsen so that import prices rise while export prices fall...
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The Multiplier - Suppose the dollar depreciates The dollar...

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