Answer to Question #264168 in Macroeconomics for KMD

Question

EXPLAIN THE DETERMINATION OF EQUILIBRIUM GDP IN A FOUR SECTOR ECONOMY WHERE GOVT SPENDING AND TRANSFER PAYMENTS ARE AUTONOMOUS

AND TAXES AND IMPORTS ARE PROPORTIONAL TO INCOME

Answer 1

The four sector model includes addition of three flows namely: exports, imports, and net capital flow which differentiates capital outflow and inflow. The C+I+G+(X-M) line indicates the total planned expenditures of consumers, governments, investors, and foreigners at each income level.

At equilibrium we have:

Y=C + I + G + (X-M)

Exports represent foreign demand for domestic output hence are part of the aggregate demand. because imports are not demands for local goods, they are subtracted from the aggregate demand. the demand for imports has an autonomous component thus it is assumed to depend on income. imports rely on marginal propensity to import which is the increase in import demand per unit increase in GDP. The demand for exports depends on foreign income therefore, it is exogenously determined. Imports are subtracted from exports to derive net exports, which are the contribution of the foreign sector to aggregate expenditures.

Equilibrium refers to the intersection between the line C+I +G+ (X-M) and the 45 degree line.

When the foreign sector is included in the model, assuming M>X, the aggregate demand schedule C+I+G shifts downward with equilibrium point shifting from F to E , and therefore a reduction in national income from yo to y1.

When X>M, the aggregate demand schedule shifts upward causing an increase in national income.