Impact of International Trade

There is one further simplifying assumption we can reconsider without leaving the simple Keynesian model behind. Recall, we began from the fact that income must, by definition, be the sum of the four categories of expenditure for final demand, expressed by Y=C+I+G+NX. The four categories are consumption, investment, government purchases, and net exports. In this chapter so far, we have made the model more realistic by allowing for changing autonomous consumption and investment. All along, however, we have been assuming that NX is zero.

This may not seem to be very important. After all, NX is net exports -- exports minus imports. Thus, we have not been assuming that there was no trade, only that trade is balanced. And, if we average over all countries, then trade has to be balanced on the average! Nevertheless, as a practical matter, trade is the most important single macroeconomic impact for some countries, especially smaller ones, and even for a big country like the United States, the macroeconomic consequences of unbalanced trade can be explosive. Accordingly, before we finish this chapter, we must bring net exports into the model.

We needn't go into much detail at this point. Net Exports is a component of autonomous expenditure, and so changes in Net Exports will have a multiplier effect, and the multiplier will be the same as that for other components of autonomous spending. In the numerical example we have been using, the multiplier is 3.33. Suppose, then, that there is some change in the country's trade situation. For example, the national currency might be devalued. That, we recall, will make imports more expensive and exports cheaper, and that, in turn, would tend to reduce imports and increase exports. For every dollar of additional exports, then, equilibrium income would increase by $3.33; and for every dollar decrease in imports, similarly, equilibrium production would increase by $3.33. Small wonder that exports are politically popular and imports are not!

As with the other components of autonomous consumption, the multiplier applies similarly to both increases and decreases in net investments. A decrease in net investments would lead to a multiple decrease in equilibrium production.

Even this is a little oversimple. It seems likely that imports, like consumption, would increase if income increases -- less than proportionately with income. This suggests a somewhat more complex model may be needed to take trade fully into account in a model of aggregate demand. However, we will leave this detail for a more advanced class -- a course in international trade theory, perhaps. But before we leave the role of trade, let's see haw a change in trade looks in our standard "Keynesian" diagram.

The Graphic View, Once More