Foreign trade multiplier

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Foreign trade multiplier also known as export multiplier, refers to exports increase. The foreign trade multiplier for income imports through a marginal propensity to import is still widely used and taught. The formulation of a foreign trade input/output multiplier may be more stable with respect to changes in parameter values than the more traditional formula of a foreign trade keynesian input/output multiplier. This is an advantage and that is why the multiplier is used for policy making and economics forecasting [1].

The value of the foreign trade multiplier is determined by the marginal tendency to save and the marginal tendency to import. Dependence between the marginal tendencies and multiplier value is that the lower marginal tendencies are, the higher the multiplier value will be[2].

Calculation of foreign trade multiplier

The foreign trade multiplier can be derived algebraically, as it is shown below[3]:

Y= C + I + X - M

Where Y stands for national income, C - national consumption, I - total investment, X - means export and M is for import.

The above reaction can be solved as follow[4]:

Y - C = I + X - M or S = I + X - M

Criticism of foreign trade multiplier

The main reasons in foreign trade multiplier criticism come from static nature and unrealistic assumption, the criticism may be consider problems as following[5]:

  1. The foreign trade multiplier depends on the unrealistic assumption that exports and investments are independent of income levels but in reality, it is not.
  2. The foreign trade multiplier is assumed to be an immediate process in which it delivers the final results. It is therefore not subject to any delays and is unrealistic.
  3. It is based on the unrealistic establishment of full employment, but full employment is not a common thing and rather than the rule.
  4. The foreign trade multiplier framework is suitable for the two-country model when more than two countries are considered, the analysis will become more complex and very difficult to interpret the foreign effects of this theory.

Examples of Foreign trade multiplier

  • The multiplier effect of foreign trade is seen in the example of a company that imports goods from abroad to be sold in domestic markets. The company's imports will increase demand in the domestic economy, which in turn increases the demand for labor and other resources. This leads to an increase in wages, which then leads to increased consumption, production and investment, all of which further stimulate the economy.
  • Another example of the foreign trade multiplier is when an economy exports goods to another country. The foreign country will pay for the goods, which increases the income of the exporting economy. This increase in income will lead to an increase in demand for labor and other resources, which in turn leads to increased wages and consumption. This ripple effect of increased economic activity can be seen in the exporting economy.
  • An example of the foreign trade multiplier in action can be seen in the European Union. As the European Union has expanded, trade between countries within the union has increased dramatically. This has had a positive effect on the economies of the countries within the union, leading to increased growth and job creation.

Advantages of Foreign trade multiplier

The foreign trade multiplier offers several advantages when used in policy-making and economic forecasting:

  • It provides an efficient way to identify and measure the effects of foreign trade on a country’s economy.
  • It can be used to analyze the impact of international trade on countries’ economic growth.
  • It can be used to evaluate the effects of various trade policies on economic growth.
  • It can be used to assess the economic impact of changes in foreign trade on a country's balance of payments.
  • It provides a more stable estimation of the effects of international trade and can be used to detect any changes in export and import trends.
  • It can be used to measure the positive and negative impacts of foreign trade on the economy of a country.

Limitations of Foreign trade multiplier

The foreign trade multiplier has certain limitations that need to be taken into account when utilizing the multiplier for policy making and economics forecasting. These limitations include:

  • Ignoring international capital flows: The foreign trade multiplier does not take into account international capital flows such as foreign direct investment, portfolio investment, and banking transfers. This can lead to inaccurate predictions of the effects of export and import changes on domestic income.
  • Not accounting for structural changes in the economy: The foreign trade multiplier does not take into account structural changes in the economy such as changes in technology, trade agreements, and shifts in demand. This can lead to inaccurate predictions of the effects of export and import changes on domestic income.
  • Not considering the impact of fiscal and monetary policies: The foreign trade multiplier does not consider the impact of fiscal and monetary policies. This can lead to inaccurate predictions of the effects of changes in government spending, taxes, and interest rates on domestic income.
  • Not taking into account changes in exchange rates: The foreign trade multiplier does not consider changes in exchange rates. This can lead to inaccurate predictions of the effects of changes in exchange rates on domestic income.
  • Not accounting for the effects of inflation: The foreign trade multiplier does not account for the effects of inflation. This can lead to inaccurate predictions of the effects of changes in prices on domestic income.

Other approaches related to Foreign trade multiplier

To further understand the impacts of foreign trade, there are other approaches related to foreign trade multipliers, such as:

  • Input-Output Analysis: It is a method used to measure the interdependencies between various sectors of the economy, and how the change in one sector affects the others.
  • Trade Theory: It is a study of the patterns of international trade and how countries can best benefit from it.
  • Balance of Payments Theory: It is the study of the international transactions between a country and the rest of the world.
  • Exchange Rate Theory: It is the study of the factors that determine the exchange rate between two countries.

In summary, foreign trade multipliers are an important tool to understand the impacts of foreign trade, and there are other approaches related to it, such as input-output analysis, trade theory, balance of payments theory and exchange rate theory.

Footnotes

  1. ↑ Currie D, Peters W (2016)
  2. ↑ Maria M, Kennedy J (2014)
  3. ↑ Kumar R (2008)
  4. ↑ Kumar R (2008)
  5. ↑ Maria M, Kennedy J (2014)


Foreign trade multiplier — recommended articles
Nominal exchange rate — Global demand — Okuns law — Monetarism — Currency Convertibility — Country risk — Endogenous growth theory — Exchange rate and inflation — Net Borrower

References

Author: Veniamin Terokhin

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