Foreign Trade Multiplier

• A Simple Keynesian Model for an open economy

without Govt. operation
Model
National Income Identity : Y=C+I+X-M
(all notations having usual implications)
C= c(Y), c/ is MPC and 0< c/ <1
I=I0, X=X0

M= m(Y), m/ is marginal propensity to import and 0< m/ <1

Suppose we seek to investigate the effect of an autonomous
changes in exports (assuming no change in private investment)

Taking the total differential :

dY= c/ dY+dI+dX- m/dY
Assuming dI=0, we get
dY= [1/(1- c/ + m/ )]dX

So, the value of For. Trade Multiplier is

or, dY/dX=[1/(s/+ m/ )]
where s/= 1- c/
Graphical Explanation

I+X

S(Y)+M(Y)

I0+X1

Io+Xo

Yo Y1 Y
Graphical Explanation
Effect on National Income of Increase in Imports

I+X
(S+M)1

(S+M)0

Io+Xo

Y1 Yo Y
 BOP Multiplier

Now we try to understand how BOP will react to

Income changes caused by autonomous change in
exports.
Change in Increase Change
Exports in Income in BOP
Through Through
For. Trade change in
Multiplier absorption

Through BOP Multiplier

Model
National Income Identity : Y=C+I+G+X-M
We write BOP=B=X-M

So, dB=dX-dM For. Trade Multiplier is

Assuming M=m(Y), m/(Y)>0 dY=[1/(s/+ m/ )]dX
we can write dB=dX-m/(Y)dY
or, dB=dX- m/(Y) {1/(s/+ m/ )}dX

In otherwords,the value of BOP

Multiplier is

dB/dX=[s//(s/+ m/)]
Under Normal Behavioural Assumption (when 0<s/<1and
0<m/<1) BOP multiplier also lie within 0 and 1
Or 0<[s//(s/+ m/)]<1

This means that as export increases leading to an

increase in national income, BOP also improves but
the improvement of BOP is less than the increase in
exports. One can expect that following an
autonomous increase in exports there must be some
increase in imports as well because of increase in
income in process.
dM=m/(Y)dY={m//(s/+ m/)}dX<1
so, dM<dX
 However, we must note two important cases

Case I: When m/(Y)=0

Then BOP multiplier equals to 1. So, dB=dX

Case II: When s/(Y)=0

Then BOP multiplier equals to 0. So, BOP will
not be affected at all by change in autonomous exports
 Foreign Trade Multiplier with Foreign Repercussion

Due to trade, countries are linked together. Any change in one

country’s national income will affect the other country’s
income through trade.
Example:
A recession in US leads to a fall in import demand of US
and thus to a fall in exports from its trading partners.
This due to multiplier effect will have a negative effect on
trading partners’ national income. This again reduces
their import demand from US and thereby affecting US
income further.
 Geometric Illustration

Stage-I, Country-I Stage-II, Country-II Stage-III, Country-I

Id,X,M,S Id,X,M,S Id,X,M,S

S+M
S+M S+M
Id/+X/

Id/+X Id/+X
Id+X/
Id+X
Id+X

Y0 Y1 Y Y Y1 Y2 Y