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Module 4 Keynes - 4 Sector

This document discusses national income determination in a four sector economy that includes exports and imports. It defines the factors that influence exports and imports. It presents export and import functions and shows how a trade balance can result. It then explains how exports and imports affect aggregate demand and derives the formula to calculate national income based on autonomous consumption, investment, government spending, exports, taxes and imports. Finally, it discusses the foreign trade multiplier and how it is lower than the multiplier for a closed economy due to imports leakage.

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Prashasti
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33 views

Module 4 Keynes - 4 Sector

This document discusses national income determination in a four sector economy that includes exports and imports. It defines the factors that influence exports and imports. It presents export and import functions and shows how a trade balance can result. It then explains how exports and imports affect aggregate demand and derives the formula to calculate national income based on autonomous consumption, investment, government spending, exports, taxes and imports. Finally, it discusses the foreign trade multiplier and how it is lower than the multiplier for a closed economy due to imports leakage.

Uploaded by

Prashasti
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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National Income Determination in a

Four sector economy


by Shikha Singh

By Shikha Siby ngh


Factors influencing Exports
 The price of exports in the domestic economy relative to the
price in other economies
 The income level of importing economies
 Tastes, preferences, customs and traditions in the other
economies
 Tariff and trade policies between domestic and other economies
 Exchange rates
 Export policy of the exporting country
Factors influencing Imports
 Price of the imports relative to the domestic prices
 Income level in the domestic economy
 Tastes and preferences for imports as compared to domestic
goods
 Tariff and trade policies of the domestic economies vis a vis the
other economies
 Exchange rate polices
Export and Import Function
 To simplify analysis we assume that in short run:
 Exports of a country are determined by the external factors
therefore it is assumed to be autonomous variable and given as
X.
 Imports in any economy are determined by the income level in
the domestic economy. So two major factors appear in the short
run import function i.e. level of income and autonomous imports.
For example, import of food grains and capital goods. So import
function can be expressed as
 M = Ma + mY where Ma is autonomous import and m is
marginal propensity to import.
Export and Import Function

Exports,
Imports M

X= M M>X
X
X>M

Ma

Y1 Y, Income
To note: from the diagram
 At all income levels below Y1, X>M, there exists a positive
trade balance. At all income levels beyond Y1, X<M, there
exists a negative trade balance
 To note: Any change in the factors that increase exports will lead
to an upward shift of export function resulting in an increase in
net export balance at each income level.
 Any change in factors that increase imports will result in an
upward shift in the import function i.e. increase in the slope
resulting in a decrease in net export balance at each income level.
Exports and Aggregate Demand
 Exports result in inflows of incomes from abroad. A part
is consumed and a part is saved. AD for an open
economy is given by
 AD = C + I + G + X ….. (1)
 Assuming there are no imports ,
 Y = 1/1-b (Ca + I + G –bT + X) …..(2)
 Therefore Export multiplier is ∆Y/ ∆X = 1/1-b
Imports and Aggregate Demand
 AD given in equation (1) is reduced by the amount of
payments for imports.
 This negative effect of imports on AD is included as a
negative value and thus
 AD = C + I + G + X – M
 If M>X, AD decrease, and if X>M, AD increases
National Income Determination in Open economy or
Four sector Model
 AD –AS approach
 Y =Y=C+I+G+X–M
 C = Ca + b Yd, Yd = Y – T, T is lumpsum tax, G, I, X are
autonomous, M = Ma + mY
 Y = Ca + b (Y – T) + I + G + X – (Ma + mY)
 Y = Ca + bY – bT + I + G + X – Ma – mY
 Y - bY + mY = Ca + I + G + X – bT – Ma
 Y(1 – b +m) = Ca + I + G + X – bT – Ma
 Y = 1/ (1 – b +m) Ca + I + G + X – bT – Ma
National Income Determination in Open economy or
Four sector Model
 Leakages equal Injections Approach
In equilibrium in a 4 sector model, AD=AS, Or, C+I+G +X = C+S+T+M [c is common on both sides],
 I+G+X=S+T+M
 Where I G X are autonomous,
 S= Yd – C, C = Ca + bYd, T=T, M=Ma + mY, we get,

 I + G + X = (Yd – C) + T + Ma +mY
 I + G + X = [Y-T – (Ca + b Yd)] +T + Ma + mY
 I + G + X = [Y – T - Ca – b(Y-T)] +T+ Ma + mY
 Y – bY + mY = Ca + I + G + X - bT + Ma
 Y(1-b+m) = Ca + I + G + X – bT - Ma
 thus, Y = 1/ (1 – b +m) Ca + I + G + X – bT – Ma
Introduction of Transfer Payments in a
Four Sector Model
 Y=C+I+G+X–M
 C = Ca + b Yd, Yd = Y – T +R, T is lumpsum tax, G, I, X, R are
autonomous, M = Ma + mY
 Y = Ca + b (Y – T +R) + I + G + X – (Ma + mY)
 Y = Ca + bY – bT + bR + I + G + X – Ma – mY
 Y - bY + mY = Ca + I + G + X + bR – bT – Ma
 Y(1 – b +m) = Ca + I + G + X – bT + bR – Ma
 Y = 1/ (1 – b +m) Ca + I + G + X – bT + bR – Ma
Foreign Trade Multiplier
 Due to an increase in the income level in other countries there occurs an
increase in exports of the domestic country.
 To meet this increased demand for exports, there is an increase in the domestic
production which leads to an increase in income hence in the consumption
expenditure(depending on MPC).
 A part of this increase in consumption expenditure is directed towards imports
depending on the marginal propensity to import.
 This will further lead to 2nd stage of expansion, though due to the leakage from
the economy in form of imports, there will occur only a restricted increase in
income.
 Further increases in the income will become smaller and smaller.
 The size of multiplier will be lower when the marginal propensity to
import is positive.
Foreign Trade Multiplier
 In a four sector economy equilibrium income level is given by
 Y = 1/ (1 – b +m) Ca + I + G + X – bT – Ma [1]
 Assume that there is an increase in exports by ∆X. Hence,
 Y + ∆Y = 1/ (1 – b +m) Ca + I + G + X + ∆X – bT – Ma [2]

 Subtracting equation 1 from 2


 ∆Y = 1/ (1 – b +m) ∆X
 ∆Y/ ∆X = 1/ (1 – b + m)
 Where b is marginal propensity to consume, m is marginal
propensity to import
 1/ (1 – b + m) is a foreign trade multiplier
Foreign Trade Multiplier

 The value of the multiplier in an open economy(4sector) is


less than that of a closed economy(3 sector).
 i.e.Value of multiplier in an open economy is less than in a
closed economy. This is because there is an additional leakage
in the form of imports. Thus as long as marginal propensity to
import is positive, the size of the multiplier gets reduced.
 A zero marginal propensity to import implies a multiplier
which is same as the ordinary multiplier, 1/1-b
To note: Foreign Trade Multiplier

 Another way of analyzing the effect of the m on the multiplier is by


expressing the multiplier as 1/1- (b-m),where
 b = marginal propensity to purchase both domestically and foreign
produced goods
 m = marginal propensity to purchase foreign produced goods
 b-m = the marginal propensity to purchase domestically produced goods.
Thus it is to be observed that,
 (a) If b = m, the value of the multiplier is =1
 (b) If b < m, the value of multiplier would be greater than 1
 (c) If m = 0 , the multiplier would become equal to the ordinary
multiplier.
Thank You

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