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Module 1

Unit Structure : 1.0 1.1 1.2 1.3 1.4 1.5 Objectives Introduction of Foreign Trade Multiplier Income determination in a multiplier in a closed economy Foreign Trade multiplier in an open economy Foreign Repercussion Introduction of the concepts External and Internal balance and Role of Monetary and Fiscal Policy 1.6 Expenditure Changing policies 1.7 Expenditure Switching policy 1.8 Introduction of Policy Mix 1.9 A case for Monetary and Fiscal Policy Mix 1.10 Meade‟s Model 1.11 Mundell‟s Model 1.12 Mundell-Flemming Model 1.13 Summary 1.14 Questions

1. 2. To understand the concept of Foreign Trade Multiplier To know the income generation process through multiplier in a closed economy. 3. To know the income generation process through the foreign trade multiplier in an open economy. 4. To study the rate of foreign repercussions on the income generation process through the foreign trade multiplier in an open economy. 5. To understand the concept of External and International balance and Role of Monetary and Fiscal Policy 6. To study Expenditure Changing Policy 7. To study the Expenditure Switching Policy 8. To understand the concept of Policy Mix 9. To study Monetary and Fiscal Policy Mix 10. To study Meade‟s Model 11. To study Mundell‟s Model 12. To study Mundell and Flemming Model 1.1 INTRODUCTION OF FOREIGN TRADE MULTIPLIER:

The original idea of multiplier was given by R. F. Kahn, this multiplier was Employment Multiplier. The Employment Multiplier



studies the effect of changes in employment on changes in income as per which the changes in income happens to be greater than the initial change in employment. It works through employment multiplier. Algebraically, ∆Y = ke · ΔE ∆Y stands for change in income. Ke stands for Employment Multiplier ∆E stands for initial change in Employment. Lord J. M. Keynes borrowed the idea of his Investment Multiplier from R. F. Kahn‟s Employment Multiplier. The PostKeynesian economists extended the Keyne‟s multiplier meant for closed economy to foreign trade multiplier meant for an open economy. The Concept of foreign trade multiplier was given by Mr. Leighton.

1.2 INCOME DETERMINATION IN A MULTIPLIER IN A CLOSED ECONOMY : In a closed economy the total national income is equal to the sum total of private spending ie C + I and the Government Spending i.e. G. When national income is looked at from the angle of total expenditure, it represents the expenditure side of the total national income of the country. Algebraically, Y=C+I+G Y stands for total national income. C Stands for total Consumption expenditure. I stands for total investment expenditure. G stands for Governmental expenditure. Since Government doesn‟t strictly follow the rules of economics its role gets omitted. Hence in a closed economy the total national income will be equal to the sum of consumption and investment expenditure. Algebraically, Y=C+I C = f (Y) Since consumption in an indigenous variable it depends upon total national income. As income rises consumption rises too but it rises at a diminishing rate I ≠ f (Y) Since Investment is an exogenous variable it is not a function of total national income.

Mcom-glob Y=C+S Y=C+I


C, C from both the equations get cancelled hence savings will be equal to investment and conversely investment will be equal to savings. Algebraically, S=I I=S If we allow time period to exert its influence on savings and investment then it will bring about changes in savings and investment. The change in savings will be equal to change in investment and vice versa. Algebraically ∆S=∆I ∆I=∆S Keynes Multiplier depends upon the marginal propensity to consume (MPC) Algebraically, K = f (MPC) K stands for Multiplier. f stands for functional relationship. MPC stands for marginal propensity to consume. The Marginal propensity to consume is equal to change in consumption upon change in income i.e. Algebraically,

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