When import increases, does it affect the equilibrium output? I think it won't affect.

Expert Solution

in an open economy case, the aggregate demand/expenditure has the following component- consumption (after taxes), investment, government spending, and net exports.

AD= C+I+G+NX

where NX= X-IM (X- exports and IM- imports)

The upward slope of the aggregate demand function is determined by marginal propensity to save, the tax rate, and the marginal propensity to import. A higher marginal propensity to save, higher tax rate, and a higher marginal propensity to import will make the AD curve flatter, since out of income, more is going into savings or taxes or imports. All these three factors result in less spending on domestic goods and services.

Now, increase in imports means that more is spend on imported goods and services, meaning less spending on domestic goods and services. Since increase in imports reduces the overall value of net exports, and net exports is a component of aggregate demand, the net decline in net exports due to rise in imports will thus, reduce the aggregate demand. With less demand for goods and services in the economy, firms will experience a rise in unplanned inventory which will force them to cut the production of output in order to balance with the reduced aggregate demand.

Hence, increase in imports will reduce the equilibriium level of output.

Rahul Sunny answered 7 months ago

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