The amount of goods that the U.S. economy imports might depend on the current state of the economy as well as on potential GDP. For example, when the economy is booming, imports usually rise. To incorporate this channel into the model, suppose the import equation is given by

Assume the remainder of the model is unchanged from the original setup, as in Table 11.1.
(a) Derive the IS curve for this new specification.
(b) What is the economic explanation for why the parameter shows up in the denominator of the new IS curve? Notice that an aggregate demand shock that increases ā by 1 percentage point now has a smaller effect on output than it did in the original IS curve. Why?

Transcribed Image Text:

IM 712 TABLE 11.1 The Setup of the Economy for the IS Curve Endogenous variables: Y C I G EX, IM National income identity: Consumption: Exports: Imports: Investment: Exogenous variables parameters. Yr 7, āc, ar ār āet' ain' b Exogenous for now (until next chapter): R