The Goods Market in an Open Market
ECONOMICS
“Chapter 19: The Goods Market in an Open Economy”
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Chapter 19: The Goods Market in an Open Economy
19-1 The IS Relation in an Open Economy
When we were assuming that the economy was closed to trade, there was no need to distinguish between the domestic demand for goods and the demand for domestic goods. They were clearly the same thing. Now, we must distinguish between the two. Some domestic demand falls on foreign goods, and some of the demand for domestic goods comes from foreigners.
The Demand for Domestic Goods
In an open economy, the demand for domestic goods is given by
Z = C + I + G – IMIe + X
The first three terms – consumption, C, investment, I, and government spending G- constitute the domestic demand for goods. If the economy were closed C+I+G. But now we have to make two adjustments.
•First, we must subtract imports
•Second, we must add exports
The Determination of C, I and G
Let’s start with the first three: The C, I and G. Now that we are assuming that the economy is open, how should we modify our earlier descriptions of consumption investment and government spending? The answer: not very much. If it all. How much consumers decide to spend still depends on their income and their wealth. While the real exchange rate surely affects the composition of consumption spending between domestic goods and foreign goods, there is no obvious reason why it should affect the overall level of consumption. The same is true of investment: the real exchange rate may affect whether firms buy domestic machines or foreign machines.
The Determinants of Imports
Imports are the part of domestic demand that falls on foreign goods. What do they depend on? They clearly depend on domestic income. Higher domestic income leads to a higher domestic demand for all goods, both domestic and foreign. So a higher domestic income leads to higher imports. Imports also clearly depend on the real exchange
“Chapter 19: The Goods Market in an Open Economy”
-------------------------------------------------
Chapter 19: The Goods Market in an Open Economy
19-1 The IS Relation in an Open Economy
When we were assuming that the economy was closed to trade, there was no need to distinguish between the domestic demand for goods and the demand for domestic goods. They were clearly the same thing. Now, we must distinguish between the two. Some domestic demand falls on foreign goods, and some of the demand for domestic goods comes from foreigners.
The Demand for Domestic Goods
In an open economy, the demand for domestic goods is given by
Z = C + I + G – IMIe + X
The first three terms – consumption, C, investment, I, and government spending G- constitute the domestic demand for goods. If the economy were closed C+I+G. But now we have to make two adjustments.
•First, we must subtract imports
•Second, we must add exports
The Determination of C, I and G
Let’s start with the first three: The C, I and G. Now that we are assuming that the economy is open, how should we modify our earlier descriptions of consumption investment and government spending? The answer: not very much. If it all. How much consumers decide to spend still depends on their income and their wealth. While the real exchange rate surely affects the composition of consumption spending between domestic goods and foreign goods, there is no obvious reason why it should affect the overall level of consumption. The same is true of investment: the real exchange rate may affect whether firms buy domestic machines or foreign machines.
The Determinants of Imports
Imports are the part of domestic demand that falls on foreign goods. What do they depend on? They clearly depend on domestic income. Higher domestic income leads to a higher domestic demand for all goods, both domestic and foreign. So a higher domestic income leads to higher imports. Imports also clearly depend on the real exchange