What is Short-Run Impact of Trade on GDP
How do changes in a nation’s trade flows affect its GDP and employment? We first analyze this question in the context of our short-run model of output determination, the multiplier model. The multiplier model shows how, in the short run when there are unemployed resources, changes in trade will affect aggregate demand, output, and employment.
The major new elements of the analysis in the presence of international trade are two: First, we have a fourth component of spending, net exports, which adds to aggregate demand. Second, an open economy has different multipliers for private investment and government domestic spending because some of spending leaks out to the rest of the world.
Table shows how introducing net exports affects output determination. This table begins with the same components as those for a closed economy. Total domestic demand in column is composed of the consumption, investment, and government purchases we analyzed earlier. Column then adds the exports of goods and services. As described above, these depend upon foreign incomes and outputs and upon prices and exchange rates, all of which are also taken as given for this analysis. Exports are assumed to be a constant level of $250 billion of foreign spending on domestic goods and services. The interesting new element arises from imports, shown in column . Like exports, imports depend upon exogenous variables such as prices and exchange rates. But, in addition, imports depend upon domestic incomes and output. For simplicity, we assume that the country always imports 10 percent of its total output, so imports in column are 10 percent of column .
Subtracting column from column gives net exports in column. Net exports are a negative number when imports exceed exports and a positive number when exports are greater than imports. Net exports in column are the net addition to the spending stream contributed by foreign trade. Total spending on domestic output in column equals domestic demand in column plus net exports in column . Equilibrium output in an open economy comes at the point where total net domestic and foreign spending in column exactly equals total domestic output in column . In this case, equilibrium comes with net exports of -100, indicating that the country is importing more than it is exporting. At this equilibrium, note as well that domestic demand is greater than output. (Make sure that you can explain why the economy is not in equilibrium when spending does not equal output.
Figure 1 shows the open-economy equilibrium graphically. To the upward-sloping line marked C +1 + G, we must add the level of net exports that is forthcoming at each level of GDP. Net exports from column of Table 1 are added to get the dot line of total aggregate demand or total spending. When the dot line lies below the black curve, imports exceed exports and net exports are negative. When the dot line is above the line, the country has a net-export or trade surplus and output is greater than domestic demand.
Equilibrium GDP occurs where the dot line of total spending intersects the 45° line. This intersection comes at exactly the same point, at $3, 500 billion, that is shown as equilibrium GDP in Table 1. Only at $3, 500 billion does GDP exactly equal what consumers, businesses, governments, and foreigners want to spend on goods and services produced in the United States.
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