Question

• explain the effects of changes in the level of domestic demand for goods (I, G or C) on the equilibrium level of Y, domestic import spending, and on the level of NX ?
• explain the effects of changes in foreign demand for domestic (exportable) goods on the equilibrium level of Y, the NX function, and the level of NX ?

Answer 1

An increase in C, I or G will stimulate aggregate spending so AD would shift to the right. in AD-AS diagram. This causes the price level to increase and income to rise as well. With greater income, people demand more imports.which is a function of their income. Now that price level is increased, the value of currency goes down and this depreciates the currency. A depreciation causes exports to increase more than the increase in imports so net exports actually increase. This implies that the equilibrium level of Y, is increased and that there is an increased domestic import spending, and an increase in overall level of net exports NX

Foreign income is now increased so they demand more of or goods. This increases exports and so once again. AD would shift to the right. in AD-AS diagram. This causes the price level to increase and income to rise as well. With greater income, people demand more imports. Now since exports are demanded, the currency appreciates and this causes some of the exports to reduce while imports to increase. Overall the effect on net exports is ambiguous but it is likely that it should rise.