Is Lm Model
Open Economy Macroeconomics: The IS-LM-BP Model
When we open the economy to international transactions we have to take into account the effects of trade in goods and services (i.e. items in the current account) as well as trade in assets (i.e. items in the capital account). Opening the economy to international trade in goods and services means that we have to take into account the increased demand for our goods by foreigners (our exports), as well as the decreased demand for our goods that occurs because we purchase foreign goods (i.e. our imports). Total expenditures in an open economy are C + I + G + NX, where NX -- net exports -- is equal to the level of exports (X) less the level of imports (V). Thus, our exports (X) represent spending by foreigners on domestic goods so they increase the level of domestic output. Imports (V), on the other hand, represent spending by domestic residents on foreign goods, so they decrease the level of (domestic) production. To analyze the effect of exports and imports on the equilibrium level of output, it is important to understand the various factors which determine the levels of exports and imports. Exports represent foreign demand for our goods and services. Foreign purchases of goods and services depend, among other things, on foreign income levels (just as our purchases of goods and services depend on our income levels). We assume that foreign income levels are constant, thus, foreigners demand a constant amount of our goods. Whether foreigners buy our goods, or some other country's goods, or their own goods, depends on the relative prices of those goods. The lower our relative price, the more of our goods they will purchase. The exchange rate is an indicator of the relative price of our goods to foreigners. We will use "e" as the domestic price of foreign currency (i.e. how many dollars must be given up to receive 1 unit of foreign currency). Let's say that e is initially 1. 5. If e ↓ , then a domestic resident will have
When we open the economy to international transactions we have to take into account the effects of trade in goods and services (i.e. items in the current account) as well as trade in assets (i.e. items in the capital account). Opening the economy to international trade in goods and services means that we have to take into account the increased demand for our goods by foreigners (our exports), as well as the decreased demand for our goods that occurs because we purchase foreign goods (i.e. our imports). Total expenditures in an open economy are C + I + G + NX, where NX -- net exports -- is equal to the level of exports (X) less the level of imports (V). Thus, our exports (X) represent spending by foreigners on domestic goods so they increase the level of domestic output. Imports (V), on the other hand, represent spending by domestic residents on foreign goods, so they decrease the level of (domestic) production. To analyze the effect of exports and imports on the equilibrium level of output, it is important to understand the various factors which determine the levels of exports and imports. Exports represent foreign demand for our goods and services. Foreign purchases of goods and services depend, among other things, on foreign income levels (just as our purchases of goods and services depend on our income levels). We assume that foreign income levels are constant, thus, foreigners demand a constant amount of our goods. Whether foreigners buy our goods, or some other country's goods, or their own goods, depends on the relative prices of those goods. The lower our relative price, the more of our goods they will purchase. The exchange rate is an indicator of the relative price of our goods to foreigners. We will use "e" as the domestic price of foreign currency (i.e. how many dollars must be given up to receive 1 unit of foreign currency). Let's say that e is initially 1. 5. If e ↓ , then a domestic resident will have