$8$:$11$

$\mathrm{.}11100$

The I S Relation in the Open Econo...

Address the following points:

The relationship between domestic demand and income $($output$)$: Explain why the domestic demand for goods is considered an increasing function of income $($output$).$ Use a graphical representation to illustrate this relationship. $(6$ Marks$)$

How the demand for domestic goods is affected by imports and exports. $(6$ Marks$)$

Explain why the trade balance is a decreasing function of output. Use a graph to support your explanation. $(6$ Marks$)$

How the equilibrium condition for output is determined. $(6$ Marks$)$

The potential impacts of increased government spending on the domestic economy and trade balance. $(6$ Marks$)$

Note: Submit it on or before July $21$st $($EoD$).$ Anyone who submits it after the deadline will not be considered. I request that CR collect copies from everyone, place them in a ZIP file, and share it with me$.$

$1$

$($a$),$ The domestic demand for goods is an increasing function of income $($output$).$

$($b$)$ and $($c$),$ The demand for domestic goods is obtained by subtracting the value of imports from domestic demand and then adding exports.

$($d$),$ The trade balance is a decreasing function of output.

The line $AA$ represents the domestic demand for domestic goods, and the line $DD$ represents domestic demand.

$AA$ is flatter than $DD.$

:$\text{'}$

$2$

$(8$:$12$

$\mathrm{.}11100$

The I S Relation in the Open Econo...

As long as some of the additional demand falls on domestic goods, $AA$ has positive slope.

The line $ZZ$ represents the demand for domestic goods $($including exports$).$

The distance between $ZZ$ and $AA$ is constant because exports do not depend on domestic income but they depend on foreign income.

Because $Y=Z,$ the equilibrium condition for output can be expressed as:

Graphically, equilibrium output is at the point where demand equals output, the intersection of $ZZ$ and the $45-$degree line.

$2$

The goods market is in equilibrium when domestic output is equal to the demand for domestic goods. At the equilibrium level of output, the trade balance may show a deficit or a surplus.

An increase in government spending leads to an increase in output and to a trade deficit.

$3$

i

$$

$(8$:$12$

$\mathrm{.}11100$

The I S Relation in the Open Econo...

An increase in government spending leads to an increase in output and to a trade deficit.

$3$

Summary:

An increase in domestic demand leads to an increase in domestic output but leads also to a deterioration of the trade balance.

An increase in foreign demand leads to an increase in domestic output and an improvement in the trade balance.

Implications:

Shocks to demand in one country affect all other countries.

Economic interactions complicate the task of policy makers. Policy coordination is not so easy to achieve.

$4$

$$i$?$

Q

$(.)$