so in this video we’re going to look at the net exports component so the nx input of aggregate demand and when we’re talking about the nx component of aggregate demand we’re talking about demand between domestic and foreign economies so when we look at the three pillars of an economy this is the demand between economies as opposed to within an economy such as consumption investment and government spending so the key thing to note here is that when we’re looking at net exports we are looking at export revenue minus import expenditure so the the value of total exports in revenue minus the expenditure the total expenditure on imports gives us net exports and when we’re thinking about net exports and trade you really want to be thinking about this in terms of exports becoming more or less competitive those are the factors which shift export revenue and import expenditure and also overall therefore net exports so we need to be thinking are exports becoming more or less competitive and this will determine whether nx increases or decreases so if they are becoming more competitive nx will increase if exports are becoming less competitive and x will decrease when nx increases this shifts aggregate demand to the right causing gdp to increase and when nx decreases the shifts aggregate demand to the left causing real gdp to contract when we are looking at imports and exports we’re talking about the marginal propensity to import so the amount imports increase per additional unit of income so the first factor to look at here is relative levels of real disposable income so if one trading partner for example becomes wealthier and there is a higher level of real disposable income their marginal propensity to import will increase because they are now relatively better off now this could come about with an increase or decrease in taxes so if we had an increase in let’s say income tax then this would lower the levels of real disposable income if we had a decrease in income tax this would increase the levels of disposable income so let’s look at an example of australia so we have here australian imports by country if there was an increase in income tax in australia this would lower the levels of rural disposable income in australia and therefore consumption for chinese goods would decline as people in australia became relatively less wealthy this would decrease australian marginal propensity to import and nx the nx component would decrease for china this would have a negative effect on chinese gdp if there was a decrease in income tax in australia the relative levels of real disposable income would increase in australia australians would become relatively wealthier and as a result their marginal propensity to import would increase this will cause australians to purchase more products from china and as a result nx would increase which would increase real gdp by shifting the aggregate demand curve to the right for china and exactly the same would hold true in terms of income so if wages or welfare rised in australia this would increase the marginal propensity to import increasing the nx inputs for aggregate demand for china this would shift aggregate demand to the right and chinese real gdp would increase conversely if there was a decrease in income so wages or welfare in australia this would decrease australia’s marginal propensity to import decreasing nx for china and causing a contraction in real gdp in chinese gdp as this shifts the aggregate demand curve to the left so relative levels of real disposable income in australia increase chinese exports increase

because the marginal propensity to import from australians which is the same as exporting to australians for china increases exports increase nx also increases this causes real gdp to increase aggregate demand increases shifts to the right relative levels of real disposable income in australia decreases the marginal propensity to import decreases in australia and exports decrease out of china this causes nx to decline shifting the aggregate demand curve to the left for china and a contraction in real gdp will take place so the next factor we can look at here is relative levels of inflation so this is where we start to look at how competitive exports are if for example inflation don’t forget is defined as the general level of prices of goods and services within an economy so higher relative levels of inflation means higher relative levels of prices of goods and services within an economy therefore exports become less competitive so the higher the price of exports the less competitive they become conversely the lower the general level of prices of goods and services within an economy relative to other economies the more competitive exports become so lower levels of relative inflation make exports more competitive and imports less competitive and higher levels of relative inflation make exports less competitive and imports more competitive so if you have a lower level of relative inflation this will increase export revenue as exports are now more competitive because of the price and import expenditure will decrease because imports have become less competitive because people would prefer to purchase domestically now because of the lower level of inflation within the economy you can see this would actually increase nx and this would therefore increase real gdp and we’re talking about the prices don’t forget here within the economy if conversely there is a higher level of inflation within an economy export revenue will decrease so we’ll just reset this export revenue would decrease okay because now exports are less competitive because of the higher domestic prices relative to other economies and imports would become more competitive because domestic consumers would look to import more their marginal propensity to import would increase because prices would be lower elsewhere so this would increase import expenditure this would have a negative effect on nx and therefore this would cause a contraction in gdp ceteris paribus so this would be negative for real gdp

so a relative exchange rate also affects the nx part of aggregate demand so a strong domestic currency increases demand for imports if a currency strengthens in value and for example previously if you if your currency is dollars and you are able to buy a product in the uk for one pounds and that one pound cost you two dollars but the dollar strengthens and now that one pound product can be purchased with one dollar you have become relatively wealthier because you can buy two of those now with your two dollars instead of one so a strong currency increases the marginal propensity to import and it decreases demand for exports so a strong currency will increase import expenditure

and at the same time it will decrease export revenue as relatively speaking exports have become less competitive because of the value of the currency this has a negative effect on nx and this will cause a contraction in real gdp if we have a weak domestic currency a weak domestic currency increases demand for exports so exports become relatively more competitive if the domestic currency is weaker this increases the marginal propensity to import of foreign economies so the marginal propensity to import domestic products with the weaker currency from foreign economies at the same time a weaker domestic currency decreases demand for imports so imports become less competitive when the domestic currency is low so a weak domestic currency increases demand for exports

and at the same time it decreases demand for imports so the marginal propensity to import will decline in an economy with a value or a weaker currency

this actually has a positive effect on that economy’s net exports and this will increase real gdp shifting aggregate demand to the right and finally we have import and export taxes so import and export taxes are really just the same as what we’ve looked at they will increase the price of imports and exports and any increase in the price of imports makes them less competitive any decrease in the price of imports makes them more competitive any increase in the price of exports makes them less competitive and any decrease in the price of exports makes them more competitive just remember with import and export taxes that demand will not actually change if the exchange rate rises or falls by the same amount as the import or export tax so if a 10 tax is put on a product and it becomes 10 percent more expensive to the rest of the world but the currency actually devalues weakens by 10 then demand is likely to actually remain about the same because it is actually no more expensive now because of the currency devaluation than it was before and actually in real life this tends to happen most of the time here we’re talking about ceteris paribus all things remain equal but in real life that tends to happen and generally speaking it’s why import export taxes don’t tend to work because exchange rates will usually adjust to meet increased or decreased demand we’re going to look at that in more detail later on in the courseso in this video we’re going to look at the net exports component so the nx input of aggregate demand and when we’re talking about the nx component of aggregate demand we’re talking about demand between domestic and foreign economies so when we look at the three pillars of an economy this is the demand between economies as opposed to within an economy such as consumption investment and government spending so the key thing to note here is that when we’re looking at net exports we are looking at export revenue minus import expenditure so the the value of total exports in revenue minus the expenditure the total expenditure on imports gives us net exports and when we’re thinking about net exports and trade you really want to be thinking about this in terms of exports becoming more or less competitive those are the factors which shift export revenue and import expenditure and also overall therefore net exports so we need to be thinking are exports becoming more or less competitive and this will determine whether nx increases or decreases so if they are becoming more competitive nx will increase if exports are becoming less competitive and x will decrease when nx increases this shifts aggregate demand to the right causing gdp to increase and when nx decreases the shifts aggregate demand to the left causing real gdp to contract when we are looking at imports and exports we’re talking about the marginal propensity to import so the amount imports increase per additional unit of income so the first factor to look at here is relative levels of real disposable income so if one trading partner for example becomes wealthier and there is a higher level of real disposable income their marginal propensity to import will increase because they are now relatively better off now this could come about with an increase or decrease in taxes so if we had an increase in let’s say income tax then this would lower the levels of real disposable income if we had a decrease in income tax this would increase the levels of disposable income so let’s look at an example of australia so we have here australian imports by country if there was an increase in income tax in australia this would lower the levels of rural disposable income in australia and therefore consumption for chinese goods would decline as people in australia became relatively less wealthy this would decrease australian marginal propensity to import and nx the nx component would decrease for china this would have a negative effect on chinese gdp if there was a decrease in income tax in australia the relative levels of real disposable income would increase in australia australians would become relatively wealthier and as a result their marginal propensity to import would increase this will cause australians to purchase more products from china and as a result nx would increase which would increase real gdp by shifting the aggregate demand curve to the right for china and exactly the same would hold true in terms of income so if wages or welfare rised in australia this would increase the marginal propensity to import increasing the nx inputs for aggregate demand for china this would shift aggregate demand to the right and chinese real gdp would increase conversely if there was a decrease in income so wages or welfare in australia this would decrease australia’s marginal propensity to import decreasing nx for china and causing a contraction in real gdp in chinese gdp as this shifts the aggregate demand curve to the left so relative levels of real disposable income in australia increase chinese exports increase

because the marginal propensity to import from australians which is the same as exporting to australians for china increases exports increase nx also increases this causes real gdp to increase aggregate demand increases shifts to the right relative levels of real disposable income in australia decreases the marginal propensity to import decreases in australia and exports decrease out of china this causes nx to decline shifting the aggregate demand curve to the left for china and a contraction in real gdp will take place so the next factor we can look at here is relative levels of inflation so this is where we start to look at how competitive exports are if for example inflation don’t forget is defined as the general level of prices of goods and services within an economy so higher relative levels of inflation means higher relative levels of prices of goods and services within an economy therefore exports become less competitive so the higher the price of exports the less competitive they become conversely the lower the general level of prices of goods and services within an economy relative to other economies the more competitive exports become so lower levels of relative inflation make exports more competitive and imports less competitive and higher levels of relative inflation make exports less competitive and imports more competitive so if you have a lower level of relative inflation this will increase export revenue as exports are now more competitive because of the price and import expenditure will decrease because imports have become less competitive because people would prefer to purchase domestically now because of the lower level of inflation within the economy you can see this would actually increase nx and this would therefore increase real gdp and we’re talking about the prices don’t forget here within the economy if conversely there is a higher level of inflation within an economy export revenue will decrease so we’ll just reset this export revenue would decrease okay because now exports are less competitive because of the higher domestic prices relative to other economies and imports would become more competitive because domestic consumers would look to import more their marginal propensity to import would increase because prices would be lower elsewhere so this would increase import expenditure this would have a negative effect on nx and therefore this would cause a contraction in gdp ceteris paribus so this would be negative for real gdp

so a relative exchange rate also affects the nx part of aggregate demand so a strong domestic currency increases demand for imports if a currency strengthens in value and for example previously if you if your currency is dollars and you are able to buy a product in the uk for one pounds and that one pound cost you two dollars but the dollar strengthens and now that one pound product can be purchased with one dollar you have become relatively wealthier because you can buy two of those now with your two dollars instead of one so a strong currency increases the marginal propensity to import and it decreases demand for exports so a strong currency will increase import expenditure

and at the same time it will decrease export revenue as relatively speaking exports have become less competitive because of the value of the currency this has a negative effect on nx and this will cause a contraction in real gdp if we have a weak domestic currency a weak domestic currency increases demand for exports so exports become relatively more competitive if the domestic currency is weaker this increases the marginal propensity to import of foreign economies so the marginal propensity to import domestic products with the weaker currency from foreign economies at the same time a weaker domestic currency decreases demand for imports so imports become less competitive when the domestic currency is low so a weak domestic currency increases demand for exports

and at the same time it decreases demand for imports so the marginal propensity to import will decline in an economy with a value or a weaker currency

this actually has a positive effect on that economy’s net exports and this will increase real gdp shifting aggregate demand to the right and finally we have import and export taxes so import and export taxes are really just the same as what we’ve looked at they will increase the price of imports and exports and any increase in the price of imports makes them less competitive any decrease in the price of imports makes them more competitive any increase in the price of exports makes them less competitive and any decrease in the price of exports makes them more competitive just remember with import and export taxes that demand will not actually change if the exchange rate rises or falls by the same amount as the import or export tax so if a 10 tax is put on a product and it becomes 10 percent more expensive to the rest of the world but the currency actually devalues weakens by 10 then demand is likely to actually remain about the same because it is actually no more expensive now because of the currency devaluation than it was before and actually in real life this tends to happen most of the time here we’re talking about ceteris paribus all things remain equal but in real life that tends to happen and generally speaking it’s why import export taxes don’t tend to work because exchange rates will usually adjust to meet increased or decreased demand we’re going to look at that in more detail later on in the course