STUDY UNIT 6

Question 1

What’s the difference between an open and closed economy?

Answer 1

in an open economy, there is no difference between the domestic demand for goods and the demand for domestic goods: it consist of C+I+G

In a closed economy, there is a difference bwteen the domestic demand for goods and the demand for domestic goods since some domestic goods falls on foreign or imported goods.

Question 2

what is the equation for an open economy for the domestic demand for goods?

Answer 2

GDE+ C+I+G-IM+X

imports must be subtracted while exports must be subtracted

Question 3

explain the consumption function

Answer 3

it is a function of disposable income YD and there is a positive

Question 4

explain the investment function

Answer 4

it is a function of the level of output and income Y and there is positive relationship between I and Y and a negative relationship between I and r

Question 5

What’s the difference between domestic demand for goods and demand for domestic goods?

Answer 5

the domestic demand for goods is the sum of consumption spending, investment spending and government spending (C+I+G) where imports are included

the demand for domestic goods is the demand for domestic goods by households, firms and government, both domestic and foreign, (C+I+G-IM/e+X)

Question 6

What happens to the change in the equilibrium income when there is a change in government spending which has a multiplier effect on the equilibrium level of output

Answer 6

the change in the equilibrium income is larger than the initial government spending

Question 7

what are the two factors that influence the level of imports?

Answer 7

domestic level of output and the real exchange rate (e)

Question 8

explain the relationship imports and domestic level of output have with each other. show a chain of events too?

Answer 8

Y increases -> IM increases ( a positive relationship)

when domestic output in the economy rises, it leads to an increase in imports. a rise in the level of output an income causes an increase in imports by both households an firms

Question 9

how does the import curve show the positive relationship between imports and output?

Answer 9

the import curve is upward sloping to reflect the positive relationship between output and imports and the slope is determined by the marginal propensity to import

Question 10

explain the relationship imports and real exchange rate have with each other. show a chain of events too?

Answer 10

e increases-> IM increases ( a positive relationship exist)

an increase in the real exchange rate reduces the cost of imports, which results to more imports.

Question 11

what are the two things that determine the level of exports?

Answer 11

the level of output of a country’s trading partners (Y*) and the real exchange rate

Question 12

explain the relationship exports have with the domestic level of output using chain of events.

Answer 12

X=X: A change in the domestic level of output does not influence the level of exports. thus exports are exogenous. if this relationship is represented on a diagram, the export curve will remain horizontal even when domestic output increases.

Question 13

explain the relationship the level of foreign output (Y*) have with exports

Answer 13

Y* increases-> X increases (a positive relationship)

Question 14

explain the relationship the real exchange (e) have with exports

Answer 14

e increases-> X decreases (a negative relationship

Question 15

explain the difference between the DD curve and the ZZ curve

Answer 15

the slope of the ZZ curve is smaller than the slope of the DD curve because imports are a positive function of the domestic level of output and income.

Question 16

what does the NX curve show?

Answer 16

it shows what happens to the trade balance (difference between exports and imports) as the domestic level of output and income increases in the economy.

Question 17

what is a trade deficit?

Answer 17

a point on the NX curve that is below the equilibrium and where imports are greater than exports

NX < 0

Question 18

what is a trade surplus?

Answer 18

a point on the NX curve that is above the equilibrium and where exports exceeds imports)

NX > 0

Question 20

what is a trade balance?

Answer 20

a point on the NX curve that is on the equilibrium and exports are equal to imports

NX = 0

Question 21

explain what will happen to the trade balance and budget if government spending increases? show the chain of events too

Answer 21

a trade deficit will occur and budget deficit increases

G increases-> Z increases-> Y increases-> IM increase-> NX decreases

Question 22

What causes a trade surplus?

Answer 22

a rise in exports, rise in demand which will lead to an increase in the equilibrium level of output and income which increases imports.

X increase-> Z increase-> Y increase-> IM increase

Question 23

what causes a movement along the NX curve?

Answer 23

a change in autonomous government spending and a change in autonomous investment spending

Question 24

what causes a shift of the NX curve?

Answer 24

a change in foreign demand

Question 25

what happens to the real exchange rate when depreciation stays the same?

Answer 25

the real exchange rate decreases

Question 26

what is the Marshall-Lerner condition?

Answer 26

the condition under which a real depreciation leads to an increase in net exports (an improvement in the trade balance)

Question 27

explain the relationship between depreciation, price of exports and imports?

Answer 27

a depreciation of the domestic currency decreases the price of exports and increases the price of imports and has a positive and negative effect on the trade balance.

Question 28

what are the positive and negative effects that depreciation has on the trade balance?

Answer 28

positive effect: the decrease in the price of exports results in an increase in exports and a decrease in imports while the trade balance improves negative effect: increase in the price of imports increases the import bill which impacts negatively on the trade balance

Question 29

what must happen for the Marshal-Lerner condition to happen?

Answer 29

exports must increase enough and imports must decrease enough.

Question 30

what are is the chain of events for the positive effect of depreciation?

Answer 30

P exports decrease-> X increase-> Z increase-> Y increases

Question 31

what are is the chain of events for the negative effect of depreciation?

Answer 31

P imports increase -> Imports Bill increase

Question 32

what's the impact of depreciation on the NX and ZZ curve?

Answer 32

the ZZ curve will shift upwards, the domestic level of output and income will increase, the NX curve will shift to the right and a trade surplus occurs

Question 33

show a chain of events of what will happen when imports increase

Answer 33

E decrease-> X increase-> Z increase-> Y increase-> IM increase-> NX decrease

Question 34

explain the relationship appreciation has with exports and imports

Answer 34

a real appreciation leads to a decrease in exports and an increase in imports thus decreasing net exports resulting in a collapse in the trade balance

Question 35

use 2 chains of events to describe the appreciation of the trade balance

Answer 35

E increase-> X decrease-> NX decrease -> Z decrease-> Y decrease E increase-> IM increase-> NX decrease-> Z decrease-> Y decrease