In the multiplier model, the net export function specifies net exports (NX) as the difference between exogenous exports (X) and imports that are dependent on income (Y). This relationship is expressed by the formula: $NX = X - mY$, where 'm' represents the marginal propensity to import.

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In the calculation of Gross Domestic Product (GDP) as total expenditure on domestic goods, net exports are included to account for international trade. Exports (X) are added because they represent foreign spending on domestically produced goods. Imports (M) must be subtracted because the other GDP components (Consumption, Investment, and Government Spending) include spending on both domestic and foreign goods. Removing imports isolates the expenditure on domestic production only. The resulting value, (X - M), is known as net exports or the trade balance.

Net Exports (Trade Balance) in GDP

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Macroeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Macroeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Macroeconomics

Exports consist of goods and services that are produced within a specific country and subsequently sold to households, firms, and governments in other countries.

Exports

A trade deficit occurs when the value of a country's imports is greater than the value of its exports. This results in a negative trade balance, where the value of exports minus imports (X – M) is less than zero. The size of the deficit is typically reported as the positive value of imports minus exports (M – X).

Trade Deficit

A trade surplus occurs when the value of a country's exports exceeds the value of its imports. This situation corresponds to a positive trade balance, where the value of exports minus imports (X – M) is greater than zero.

Trade Surplus

In 2010, the trade balances of the United States and China provided a clear example of contrasting international economic positions. The U.S. experienced a trade deficit equivalent to 3.4% of its GDP, while China recorded a trade surplus of 3.6% of its GDP.

Example of Trade Imbalances: US and China (2010)

In reality, net exports are influenced by several factors beyond what is assumed in simplified models. Key determinants include: 1) A country's relative production costs—a decrease in these costs allows goods to be sold at lower prices on world markets, which in turn increases demand for exports while decreasing domestic demand for imports. 2) The currency exchange rate, which directly alters the prices of a country's goods in the global marketplace. 3) The rate of economic growth in world markets, as this drives the overall demand for a country's exports.

Real-World Determinants of Net Exports

In the multiplier model, it is assumed that the quantity of imported goods and services is determined exclusively by the level of domestic income. As national income increases, a specific fraction of that new income is spent on imports. This relationship simplifies the model by treating imports as an endogenous variable dependent solely on income.

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