Question

Assuming the economy is operating below its potential output, how does an increase in net exports affect real GDP? Why is it difficult, perhaps even impossible, for a country to boost its net exports by increasing its tariffs during a global recession?

Short answer

An increase in net exports increases the real GDP.

Tariffs cannot boost the economy’s net exports in times of global recession because all the economies apply tariffs on the other trading partners in retaliation. As a result, international trade fails.

Step-by-step solution

Step 1. Effect of increase in net exports on real GDP

Since the economy is operating below its potential, there is unused capacity to increase the output. The aggregate spending in a private economy is C + I_g + X_n' producing a Y equilibrium output level below its potential.

An increase of net exports in the economy will increase the aggregate expenditure to C + I_g + X_n'. Therefore, the equilibrium level of output or real GDP increases to Y’, which is the potential output for the economy.

Step 2. Effect of tariffs on net exports during a global recession

Economies impose tariffs on imports to increase their net exports. Economies assume that a hike in import taxes and duties will restrict their imports, and their exports will float freely in the international economy. Unfortunately, this assumption does not help the economies.

During the global recession, all the economies face low growth and stagnant economic activities. When one economy imposes tariffs on its imports, it restricts the exports of other trading partners. In retaliation, the other partners impose tariffs on the domestic economy’s exports.

The subsequent rounds on retaliation and tariff impositions reduce the overall foreign trade, resulting in severe depression and collapse of the global international exchange system. Therefore, tariffs cannot help a country increase its net exports in the situations like a worldwide recession.