The Open-Economy Multiplier

Surprisingly, opening up an economy lowers the mu tipsier One way of understanding the expenditure multiplier in an open economy is to calculate the rounds of spending and responding generated by an additional dollar of government spending, investment, or exports. Suppose that Germany needs to buy American computers to modernize antiquated facilities in what used to be E~t Ger tan:’. Each extra dollar of U.S. computers Will generate. $1 of income in the United States, of which 2/3 = $0.667 will be spent by Americans OD consumption. However, because the marginal propensity to import is 0.10, one-tenth of the extra dollar of income, or $0.10, will be spent on foreign goods and services, leaving only $0.567 of spending on domestically produced goods. That $0.567 of domes- .tic spending will generate $0.567 of U:S. income, from which 0.567 X $0.567 = $0.321 will be spent on consumption of domestic goods and services in the next round. Hence the total increase in output, or the open-economy multiplier.

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