Question

While exports must be added to the total final expenditures, imports must be deducted from the total final expenditures to arrive at the aggregate demand.

Short answer

Question: Explain the relationship between exports, imports, and aggregate demand in an economy. Answer: In an economy, the relationship between exports, imports, and aggregate demand is important because it helps us understand the total demand for goods and services in the domestic market. Aggregate demand is the sum of personal consumption, investments, government expenditures, and the difference between exports and imports (net exports). Exports are the goods and services produced domestically and sold overseas, whereas imports are the goods and services bought from other countries. To calculate aggregate demand, we need to deduct imports (goods and services consumed but not produced domestically) from exports and add the result (net exports) to the other components of total final expenditures. In other words, aggregate demand equals personal consumption, investments, government expenditures, and net exports (C + I + G + (X-M)).

Step-by-step solution

Understand the terms involved

Exports are the goods and services produced in a country and sold to other countries, and imports are the goods and services bought from other countries. Aggregate demand is the total amount of goods and services demanded in a country at a given price level.

Calculate Total Final Expenditures

Total final expenditures represent the sum of all the spending components in an economy. These include personal consumption (C), investments (I), government expenditures (G), and net exports (X-M), where X is exports and M is imports. So, Total Final Expenditures = C + I + G + (X-M)

Deduct Imports from Exports

In order to calculate the aggregate demand, we must take into account the difference between exports and imports. This is because total imports (M) are the goods and services that are not produced domestically but consumed, and they should be deducted from the total final expenditures to account for domestic production only. So, Net Exports = X - M

Add Net Exports to Total Final Expenditures

Now that we have calculated Net Exports, we can add it to the components of total final expenditures. Aggregate demand will be the sum of C, I, G, and Net Exports (X-M). Therefore, Aggregate Demand = C + I + G + (X-M)