Further features of the demand curve

Question 1

Open economy multiplier

Answer 1

The multiplier tells us how much output will rise after an increase in the exogenous components of demand.

The IS curve is steeper in the open economy because the multiplier is smaller in the open economy, due to imports. Thus, income ‘leaks abroad”

This means that for a given change in y, there needs be a larger rise in r.

Question 2

Define Marginal propensity to import

Answer 2

Marginal propensity to import captures the proportion of the last pound of spending that is spent on imports.

Imports become a function of income M = my.

Between zero and one.

Question 3

IS curve: Open and Closed economy

Answer 3

y = 1/1-c1(1-t)+m (c0 + I(r) + G + X bar)

X bar bc exports are assumed exogenous.

Open economy multiplier < Closed economy multiplier

1/1-c1(1-t)+m < 1/1-c1(1-t)

Question 4

What causes the IS curve to shift?

Answer 4

Changes in the real exchange rate (Q) and changes in world output (y*).