Use a diagram like that in Fig. 13.7a to analyze the effect on a country's net exports of a beneficial supply shock that temporarily raises full-employment output by 100 per person. Assume that the basic classical model applies so that income is always at its full employment level.

a. Suppose that, in response to the temporary increase in income, the residents of the country do not change the amount they desire to spend at any real interest rate (on either domestic or foreign goods). What is the effect of the supply shock on the country's net exports? What is the effect of the increase in income on the curve representing desired saving minus desired investment? What is the effect on the curve representing net exports?

b. Now suppose that, in response to a temporary increase in income, the residents of the country increase their desired spending at any real interest rate by 100 per person. A portion of this increased spending is for foreign-produced goods. What is the effect on the country's net exports?

c. More difficult: If the increase in income is temporary, would the spending behavior assumed in part (a) or the spending behavior assumed in part (b) be more likely to occur? Based on your answer, do the results of this problem confirm or contradict the prediction of the model in Chapter 5 of the response of net exports to a supply shock? Explain.

Fig. 13.7a

Transcribed Image Text:

Domestic real interest rate, r 11 F 0 E A temporary increase in government purchases (Sd-Id)2 (Sd-Id)1 NX Desired saving less desired investment, Sd-Id, and net exports, NX