Foreign Trade Multiplier | What is Foreign Trade Multiplier?

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In simple words, Trade is a basic economic concept which involving the buying and selling of goods or services from one person to another entity. In other words, Trade involves the transfer of goods and services from one person to another. So friends, in today’s article we are going to know about Foreign Trade Multiplier. So let’s discuss in details.

What is Foreign Trade Multiplier?

Foreign Trade Multiplier definition in economics – It shows the relationship between change in export and change in income. The foreign trade multiplier is also known as export multiplier. It is based on two concepts, (i) MPS and (ii) Marginal Propensity to import. It is expressed as follows –

Foreign Trade Multiplier Formula –   Kf = ΔY/ΔX

Where,

Kf = Foreign trade multiplier,

ΔY = Change in income,

ΔX = Change in export.

Derivation of Foreign trade Multiplier

We know that, export (X) is the sum of domestic saving (S) and import (M).

X = S + M

⇒ ΔX = ΔS + ΔM

Dividing both sides by, ΔY we get –

ΔX/ΔY = ΔS/ΔY + ΔM/ΔY

⇒ ΔX/ΔY = MPS + MPM

⇒ ΔY/ΔX = 1/MPS + MPM

⇒ Kf = 1/MPS + MPM

Thus, it is clear to us that foreign trade multiplier depends on the value of MPS and MPM.

Explain how National Income is determined in an open Economy?

The national income identity of an open economy is given by –

Y = C + I + X – M

⇒ Y – C = I + X – M

⇒ S = I + X – M   [ We know that Y – C = S]

⇒ S + M = I + X

Thus, at the equilibrium point the sum of saving and import (S + M) must be equal to sum of investment and export (I + X). At the point of equilibrium we also get –

S = I  ———— (i)

In an open economy, total investment includes two types of investment – domestic investment (Id) and foreign investment (If). Thus we get –

I = Id + If ———— (ii)

Again, foreign investment is the difference between export and import of goods and services. It means –

If = X – M ———— (iii)

Now, equation (ii) can be written as –

I = Id + X – M ———— (iv)

Now, putting (iv) into (i) we get –

S = Id + X – M

⇒ S + M = Id + X

This is the equilibrium condition of national income in an open economy. It can be explained with the help of following diagram –

Foreign Trade Multiplier | What is Foreign Trade Multiplier?
In the above figure, on OX axis we measure income and on OY axis we measure investment, saving, export and import. S(Y) is the saving function and (S + M) is the saving + import function. Id is the domestic investment function. (Id + X) is the investment + export function.

At point E both (S + M) and (Id + X) functions intersect each other. This is the equilibrium point which determines OY level of income. Here OY represents equilibrium national income in an open economy.

Note : Same Answer following the three questions –

• Explain how national income is determined in an open economy?

OR

• Explain diagrammatically how export affect the equilibrium national income of a poor country.

OR

• Write a note an Foreign Trade Multiplier?

Conclusion

So friends, this was the concept of Foreign Trade Multiplier. Hope you get the full details about it and hope you like this article.

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