A small country with a marginal propensity to save of 0.30 and a marginal propensity to import of 0.20 experiences an increase in exogenous spending of $3 million.a. According to the spending multiplier, by how much will domestic product and income change?b. What is the change in the country's imports?c. If this country is large (rather than small), what effect will this have on foreign product and income? Explain.d. Will the change in foreign product and income tend to counteract or reinforce the change in the first country's domestic product and income? Explain.
What will be an ideal response?
POSSIBLE RESPONSE:
a. The domestic product and income would increase by [$3 million/ (0.3 + 0.2)] = $6 million.
b. The change in the country's imports is ($6 million × 0.2) = $1.2 million.
c. If this country is large, foreign product and income will increase. The country's imports are a foreign country's exports. As exports of the foreign country rise, foreign gross domestic product (GDP) will increase because exports are an element in foreign aggregate demand.
d. As foreign exports increase, the foreign country's gross domestic product (GDP) will increase. The increase in foreign GDP will then increase foreign imports. Increased foreign imports mean increased exports for the first country, reinforcing the change in its GDP.
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