FOREIGN TRADE MULTILIER AND GLOBAL

REPERCUSSIONS
Economic Growth and Economic Development is normally measured by its National Income.
Continuous rise in National Income indicates positive growth and development of the
economy. Indias nominal GDP (Gross Domestic Product) was $ 1.847 trillion raking India at
10th position in the world in 2011. In term of purchasing power parity India held 3 rd rank in the
world with $ 4.530 trillion in 2011.

MEASUREMENT OF NATIONAL INCOME IN A CLOSED

ECONOMY
In a closed economy National Income is measured as sum total of the factor earning.
In other words it is the sum total Rent, Wages, Interest, and Profit earned in a country. It is
also the sum total of expenditure undergone by the people during a year.
In closed economy, there are no government activities. Therefore National Income equal Total
rational expenditure.
Y= C + I = C + S
Y= National Income.
C=

Aggregate Consumption Expenditure.

I=

Aggregate Investment

S=

Aggregate Saving

Saving is leakage of money from the economy and investment is injection of money into the
economy

EQUILIBRIUM OCCURS WHEN S = I

If there is increase in Investment ( I , there will be increase in saving too.

= I

Here, Multiplier effect refers to change in National Income multiple times of change in
investment. Whenever there is change in Investment in an economy, NI (National Income)
with change multiple times of change in investment.
Change in saving depends upon Marginal Propensity to save (MPS).

Therefore K =

1
1

MPS 1MPC

K=

Value of Multiplier.

MPS=

Marginal Propensity to save.

MPC=

Marginal Propensity to Consume.

If MPS is 0.2
Then Multiplier will be K =

1
0.2

=5

It means if Marginal Propensity to save of the people is 0.2, it will increase the National
Income of a country by 5 times.
Y
Y =

I =

=K

Change in National Income.

Change in Investment.

In our example K = 5
Suppose Investment in a country increased by ` 100 Crores. Then change in National Income
will be ` 500 Crore.

= 5 100 Crores = be ` 500 Crore. If Saving are greater than Investment there

in contraction in the economy in NI (National Income) and if Saving are less than Investment,
there is expansion of NI (National Income)

NATIONAL INCOME IN OPEN ECONOMY

In an open economy equilibrium
Condition is:
S=I+XM
S=

Saving.

I=

Investment.

X=

Export.

M=

Import.

or

S+M=I+X

IN OPEN ECONOMY

1. If I + X is Greater than S + M there is increase in National Income and expansion of

2.
3.

economy.
If I + X is Less than S + M there is Contraction of economy and (NI) National Income.
If I + X = S + M economy is equilibrium.
TO SUMMARISE
Expansion
Contraction
Equilibrium

Closed Economy
I>S
I<S
I=S

Open Economy
I+X>S+M
I+X<S+M
I+X=S+M

FOREGIN TRADE MULTIPLIER

It refers to the impact of increase in exports of a country on NI (National Income).
In other words it explains that increase in exports of a country brings multiple times increase
in national income depending upon Marginal Propensity to save (MPS) and Marginal
Propensity to import (MPM).
Smaller the MPS and MPM higher will be the valve of multiplier. It means larger the increase
in National Income and Vice Versa.
In other words increase in Net exports brings multiple increases in National Income.

ASSUMPTION
1.
2.
3.
5.

Full employment in the domestic economy.

Fixed exchange rate system.
No tariff barriers and exchange controls.
4. No time lag between saving and investment and income and expenditure (S & I & I & E)
Government expenditure is constant.
Foreign Trade Multiplier =
Kt=

1
S+ M

K t=

Valve of Foreign Trade Multiplier.

S=

Marginal Propensity to save (MPS)

M=

Marginal Propensity to import (MPM)

S
+
M

Saving/
Investment

e
1

Exports/
Imports

X
1
X

X2
Y

X
O
OY=

National
Income
Original National Income.

X=

Horizontal line X is Original Export.

X1=

Horizontal line X1 shows rise in exports.

OY1=

Rise in income due to rise in net exports.

e=

Original equilibrium point I + X = S + M

e1 =

New equilibrium point after rise in exports

Y

= S + M

+ X

CRITICISM OF FOREIGN TRADE MULTIPLIER

1. Time Lag: Foreign trade multiplier is based upon the unrealistic assumption of no time
lag.
2. Full Employment: In reality there is less than full employment. Foreign trade multiplier
is based upon the unrealistic assumption of full employment
3. Ignores Fiscal Measures: This theory ignores government measures which interfere
with foreign trade of a country.
4. Imports are leakage: Sometimes imports of capital goods may help in significant
improvement in productivity adding to increase in National Income.

GLOBAL REPERCUSSIONS OF FOREIGN TRADE MULTILIER

Though Global trade countries are interrelated in multilateral trade a country enter into
imports and exports of large volume of goods and services. In this process one country
imports become another countries exports. A country exports and imports affect the national
income of trading partners, which will again have an impact on the country which initially
started exporting, E.g. Recession of 2008 which affected U.S.A and its trading partners.
Indias exports to U.S.A also declined and national income was affected.
This chain of action is termed as Back Wash Effect or Foreign Repercussion. This effect is
especially felt by large countries, whereas in case of small countries it is almost negligible.

Example:
Two Countries Model
Country A

Country B

Increase in export

Increase in Import

Increase in National
Income, output, employment,

Increase

in

Export
Consumption etc

Increase in Imports also

Increase in NI,
Output, employment,
Consumption etc

Increase in Exports
Import

Increase

in

IMPLICATION OF FOREIGN REPERCUSSIONS

1. The effect of Prosperity: The effect of prosperity or depression is passed to and from
major trading partners.
2. Economic Fluctuation: Economic fluctuation affects the national income and economic
growth of all trading partners. E.g. Current economic slowdown in Europe.
3. Foreign trade multiplier affects the balance of trade of a country: Increase in export
may lead to rise in National Income and Economic Growth with favourable balance of
trade. On the other hand rise in imports may lead to fall in National Income and
Economic growth with unfavorable balance of trade.
4. A countrys policy to promote export and reduce import to remove unemployment and
increase national income (beggar-thy-neighbour policy) may reduce the income and
employment level of importing country and in the long run it will create adverse impact
on exporting country.
5. If imports are excess over export, there will be reverse operation of multiplier resulting
into worst situation due to fall in income output and employment.
6. A country with excess export over import will face inflation due to excess money supply
and its multiple effects will influence the level of national income and economic growth.