Before we analyse the combined effect of exports and imports on the national income, let us first analysis separately the effect of export and import on the national income. Let us begin by looking at the export and import functions, their determinants and how they affect the aggregate demand and the national income.
Export function and export multiplier
Like C, I and G. exports of goods and services constitute a part of the aggregate demand in an economy and its effect on the economy is also the same. There is however a difference. The demand of consumer goods (C), investment goods (I) and the government purchases (G) originate within the economy and is called domestic demand. By the demand for exports originates outside the economy. It is therefore called the external demand. Let us look at the determinants of exports and the export function.
Exports of a country are a function of a number of external and internal factors. Some of the important external determinants of exports of a country are: (i) domestic prices fo exports in relation to those importing countries, (ii) income of the importing countries, (iii) importers income-elasticity for imports, (iv)their tariffs and trade policy and (v) their exchange rate policy and foreign exchange restrictions. Some of the important internal determinants of exports of a country include; (i) export policy fo the exporting country, (ii) export duties and subsidies, (iii) availability of exportable surplus, (iv) tirade and tariffs agreements with other countries, and (v) international competitiveness of domestics goods.
Exports and aggregate demand
As noted above, in an open economy exports constitute a part of the aggregate demand. Exports result in inflows of incomes from abroad. A part of this income is consumed and a part saved the increase in consumption due to increase in exports affects the economy in the same manner as the increase in consumption due to increase in income. Since exports constitute a part of the aggregate demand, AD for an open economy is given as
AD = C + I + G + X
Assuming there are no imports, the equilibrium level of the national income with exports can be written as:
Y = C + I + G + X
C = a + b (Y – T)
The equilibrium level of income in an economy with no imports can be obtained by substituting Eqs. Thus
Y = a + b(Y-T) + I G + X
Y = 1 / 1-b (a – bT + I + G + X)
Given the Eq, the export multiplier (X-multiplier) can be easily worked out. Assuming an increase in exports,∆X, national income equilibrium equation can be rewritten as:
Y + ∆Y = 1/1-b (a – bT + I + G + X + ∆X)
Subtracting Eqs, we get
∆Y = 1/1-b (∆X)
∆Y/∆X = 1/1-b = X-multiplier
Let us now look at the determinants of imports and their effect on the aggregate demand and on the national income. We begin by specifying the import function. Imports are purchases of goods and services from abroad, payments for imports are a leakage from the income stream because payments made for imports make the domestic income flow out of the economy the level of imports determines the level of outflow of domestic income.
Imports and aggregate demand
The aggregate demand as given in Eq. is reduced by the amount of payments fo imports. This negative effect of imports on the aggregate demand is accounted for by including imports (m) as a negative value in the aggregate demand equation. Following the national income accounting conventions, only exports net of imports (X –M) appear in the aggregate demand equation. Thus the aggregate demand equation for an open economy is expressed as:
Y = C + I + G + (X – M)
Equation means that if M > X, the aggregate demand decreases, and if X > M, the aggregate demand increases.