If the imports of an economy consistently exceed the exports of an economy, then the net exports will be negative.
Negative net exports will push down the equilibrium level of GDP
Based on the discussion in the chapter, increase in net exports will have a multiplier effect on GDP. It means a small increase in net exports will cause an increase in GDP at a higher rate. On the other hand, a small fall in net exports will cause the GDP to fall at a higher rate.
Thereby, the multiplier effect of negative net exports will push the equilibrium level of GDP down.
Definition of Multiplier
The multiplier effect explains the effect of change in any component of GDP on GDP. The consumption multiplier effect depends on the marginal propensity to consume
, which lies within the range of zero to one.
Marginal propensity to consume is the additional units of consumption made to the total consumption in response to change in disposable income.
Reason behind range of b is zero to one
Marginal propensity to consume lies in the range of zero to one because income can be either consumed or saved; if whole income is consumed, then b will be₁ and multiplier effect will be infinitive. On the other hand, if whole income is saved, then consumption is zero; hence, the multiplier effect of consumption will be zero. It means the b coefficient will be zero.
Since the sum of consumption and saving cannot exceed the total income, the value of b coefficient lies within 0 to 1.
The equilibrium level of GDP is $6,000.
If the real GDP is greater than or less than the equilibrium level, the following problem will occur.
If real GDP is below equilibrium level
If the level of GDP falls to $5,000, then the actual GDP will be less than the planned GDP.
When the actual GDP is less than the planned GDP, it will increase the recessionary gap. It implies that the actual GDP is below the potential level.
If real GDP is above equilibrium level
If the level of GDP increases to $7,000, then the actual GDP will be higher than the planned GDP.
When the actual GDP is greater than the planned GDP, it will increase the inflationary pressure. It implies that the actual GDP is higher than the potential level.