Question

Create an example (make up your own numbers) for a virtual open economy with import as a function of total income. Find the equilibrium output level and the open economy multiplier. ı sent this question before but I couldn't read most of the answer.

Answer 1

Open economy is an economy which gave an economic relations with the rest of the world....AD = C+I+G+X-M

Here the import is the function of Total income M = M(Y)... marginal propensity to import shows the ratio of changes in the imports to changechanges in the level of income

For example,

Consumption =500+0.9Y , I = 1000 , G = 250 NX = ( X = 500 , M = 200 ) 300

The equilibrium level of output (Y) =

C+I+G+NX

Y = 500+0.9Y+1000+250+300

Y-0.9Y = 2050

0.1 Y = 2050/0.1

Y = 20500

2) Open economy multiplier = 1/MPS+ MPM

where MPS is marginal propensity to save and MPM is marginal propensity to import

Eg : suppose, the income of the economy increases from 20500 to 30500 , so that consumption is also increased from 500 to 1000 as a result the import of country A raised from 200 to 400..the open economy multiplier is equal to

MPS = 1-MPC

MPC = change in consumption / change in income

MPC = 500/1000

MPC =0.5

which means 0.5 is the MPS . The reason is MPC + MPS =1

Similarly we need to calculate MPM

MPM = change in the imports / change in the income

MPM = 200/1000

MPM = 0.2

The open multipler effect can be calculated with the help of the following equation ..In the below equation, Knm denotes open economy multiplier

Knm = 1/MPS+ MPM

= 1/0.5+0.2

= 1/ 0.7

= 1.43

Here I have used similar numbers used in two examples to find out the equilibrium level of output and open economy multiplier....