Question

What is the so-called foreign trade multiplier argument? What conclusion can we derive from the said argument?

Short answer

The foreign trade multiplier, or export multiplier, refers to the magnifying effect of increased exports on a country's national income. It depends on factors such as the marginal propensity to consume (MPC), the marginal propensity to import (MPI), and the marginal propensity to save (MPS). The formula to calculate the foreign trade multiplier is: \(\frac{1}{(1 - MPC(1 - MPI) + MPS)}\). The main conclusion derived from this argument is that an increase in exports leads to a greater increase in national income, as it triggers an upward spiral of income, consumption, and production. Countries with higher MPC or lower MPI and MPS experience a stronger multiplier effect, resulting in more significant impacts on economic growth and development.

Step-by-step solution

Explain the foreign trade multiplier

The foreign trade multiplier, sometimes called the export multiplier, is an economic concept that refers to the magnification effect of an increase in exports on a country's national income. In simple terms, an increase in exports leads to an increase in domestic production, which subsequently increases national income.

Factors affecting the foreign trade multiplier

The magnitude of the foreign trade multiplier depends on several factors, such as the marginal propensity to consume (MPC), the marginal propensity to import (MPI), and the marginal propensity to save (MPS). The greater the MPC, the higher the multiplier, as people spend more of their additional income. Meanwhile, the higher the MPI and MPS, the lower the multiplier, as people use a larger share of their extra income to import goods or save. Using the following formula, you can calculate the foreign trade multiplier: Foreign trade multiplier = \(\frac{1}{(1 - MPC(1 - MPI) + MPS)}\)

Conclusion

One of the main conclusions derived from the foreign trade multiplier argument is that an increase in exports will lead to a more significant increase in a country's national income. This occurs because the initial increase in exports triggers an upward spiral of increased income, consumption, and production. Another conclusion we can derive from the foreign trade multiplier is that countries with a higher MPC or a lower MPI and MPS will experience a stronger multiplier effect. This means that the impact of exports on national income will be more significant in such countries, which can help spur economic growth and development further.

Key concepts

Marginal Propensity to Consume

The marginal propensity to consume (MPC) is a vital concept in understanding how household spending reacts to changes in income. It measures the proportion of extra income that households are likely to spend on consumption rather than saving. For instance, if individuals on average spend 80 cents out of an additional dollar they earn, the MPC would be 0.8. This concept is crucial in the multiplier analysis because the higher the MPC, the greater the induced consumption from every increase in national income, enhancing the overall effect of the foreign trade multiplier.

Significance in Economic Policy

Knowing the MPC helps governments and policymakers predict the impact of fiscal policies such as tax cuts or stimulus checks. If consumers have a high MPC, these policies might lead to a significant increase in overall demand within the economy.

Marginal Propensity to Import

The marginal propensity to import (MPI) complements our understanding of how economies interact with the global market. It indicates the fraction of additional national income spent on imported goods and services. A higher MPI dampens the foreign trade multiplier because when domestic income increases, more of that income is used to purchase imports rather than domestic goods, which sends the income abroad. Consequently, the domestic economic cycle benefits less from each round of spending.

For example, if the MPI is 0.3, it means that 30% of the increase in income is spent on imports. Countries aiming to enhance their foreign trade multiplier effect might look into policies that reduce the MPI, such as promoting domestic industries or implementing import substitution strategies.

Marginal Propensity to Save

Marginal propensity to save (MPS) is the portion of additional income that a household saves rather than spends. The MPS plays an inverse role in the functioning of the foreign trade multiplier; when the MPS is high, less spending circulates back into the economy from additional income, thus weakening the multiplier effect. A higher MPS suggests a more cautious or less optimistic outlook from consumers regarding the future economic situation, or a preference for future consumption over present consumption.

Fiscal Implications

Policy measures like interest rate adjustments by central banks can influence the MPS. For example, higher interest rates might incentivize saving over spending, leading to a potentially higher MPS and a less robust multiplier effect.

National Income

National income represents the total amount of money earned within a country from the production of goods and services over a specific period, usually one year. It includes wages, profits, rents, and taxes minus subsidies. National income is a marker of economic performance and is related to the concepts of gross domestic product (GDP) and gross national product (GNP). The foreign trade multiplier effect plays a significant role in enhancing national income through the cycle of increased exports leading to higher domestic production and income.

Thus, understanding the factors that influence national income, such as consumer behavior (signified by MPC and MPS) and international trade (affected by MPI), is essential for strategizing economic growth.

Economic Growth

Economic growth refers to the sustained increase in a country's output of goods and services over time. Measured typically as the percent rate of increase in real GDP, growth is influenced by many factors, including labor productivity, technological advancements, capital investments, and, importantly, the level of aggregate demand stimulated by the foreign trade multiplier. A vital conclusion from the multiplier concept is that boosting exports can substantially influence economic growth, provided the MPC is sufficiently high and the MPI and MPS are relatively low.

Growth Strategies

Different countries may aim to enhance economic growth by adopting policies that encourage exports, stimulate consumer spending (increasing MPC), or create a conducive environment for domestic production over imports (reducing MPI).