Macroeconomics 12th Edition by Rudiger Dornbusch ,Stanley Fischer,Richard Startz

Exercise 6

This question is concerned with the repercussion effects of a domestic expansion once we recognize that, as a consequence, output abroad will expand. Suppose that at home there is an increase in autonomous spending, D A , that falls entirely on domestic goods. (Assume constant interest rates throughout this problem.)
a. What is the effect on income, disregarding repercussion effects What is the impact on our imports Denote the increase in imports by

b. Using the result for the increase in imports, consider what happens abroad. Our increase in imports means that foreign countries experience an increase in their exports and therefore an increase in the demand for their goods. In response, their output expands. Assuming the foreign marginal propensity to save is s * and the foreign propensity to import is m *, by how much will a foreign country's income expand as a result of an increase in its exports
c. Now combine the pieces by writing the familiar equation for equilibrium in the domestic goods market: Change in supply,
equals the total change in demand,



Noting that our increase in exports,
is equal to foreigners' increase in imports, we can replace
with the answer to part b to obtain a general expression for the multiplier with repercussions.
d. Substitute your answer to part b in the formula for the change in our exports,

e. Calculate the complete change in our income, including repercussion effects. Now compare your result with the case in which repercussion effects are omitted. What difference do repercussion effects make Is our income expansion larger or smaller with repercussion effects
f. Consider the trade balance effect of a domestic expansion with and without repercussion effects. Is the trade deficit larger or smaller once repercussion effects are taken into account