In an open economy, exports are fixed at 230 and imports are given by M = 50 + 0.2Y. Income rises from 1,000 to 1,200. What happens to net exports?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → They change from −20 to −60
Exports do not depend on our own income, but imports rise with income through the marginal propensity to import. So net exports fall as income rises.
Given:
X = 230
M = 50 + 0.2Y
Y rises from 1,000 to 1,200
\( \displaystyle \text{At } Y = 1000: \; M = 50 + 200 = 250, \; NX = 230 - 250 = -20 \)
\( \displaystyle \text{At } Y = 1200: \; M = 50 + 240 = 290, \; NX = 230 - 290 = -60 \)
Net exports fall from −20 to −60: the trade deficit widens by 0.2 × 200 = 40.
Option (1) They change from −20 to 20 — Incorrect. Higher income raises imports, so net exports fall; they cannot turn positive.
Option (2) They change from 30 to −10 — Incorrect. This leaves out the autonomous imports of 50.
Option (3) They stay at −20 — Incorrect. Imports are not fixed: they rise by 0.2 of every extra rupee of income.
NCERT (2026-27): “DETERMINATION OF EQUILIBRIUM INCOME IN OPEN ECONOMY where, NX is net exports (exports – imports). A positive NX (with exports greater than imports) implies a trade surplus and a negative NX (with imports exceeding exports) implies a trade deficit. … The demand for imports depends on domestic income (Y) and the real exchange rate (R ). Higher income leads to higher imports. …” “M = M + mY, where M > 0 is the autonomous component, 0 < m < 1. (6.5) Here m is the marginal propensity to import, the fraction of an extra rupee of income spent on imports, a concept analogous to the marginal propensity to consume. …” |