In an open economy (Rs crore), C = 30 + 0.75(Y − T), lump-sum taxes T = 40, investment I = 50, government purchases G = 60, exports X = 40 and imports M = 10 + 0.25Y. What are the equilibrium income and the trade balance?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Rs 280 crore; a trade deficit of Rs 40 crore
Add up all the autonomous spending (the part that does not depend on income). Equilibrium income is that total ÷ (1 − c + m). Then imports at that income give the trade balance, X − M.
Given:
C̄ = 30
c = 0.75
T = 40
I = 50
G = 60
X = 40
M = 10 + 0.25Y (Rs crore)
\( \displaystyle \bar{A} = 30 - 0.75 \times 40 + 50 + 60 + 40 - 10 = 140 \)
\( \displaystyle Y^{*} = \frac{140}{1 - 0.75 + 0.25} = \frac{140}{0.5} = 280 \)
\( \displaystyle M = 10 + 0.25 \times 280 = 80 \)
\( \displaystyle NX = 40 - 80 = -40 \)
Income is Rs 280 crore with a trade deficit of Rs 40 crore.
Option (1) — Rs 560 crore uses the closed economy multiplier, 4, on 140.
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. …” “… 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. …” “… Since m, the marginal propensity to import, is greater than zero, we get a smaller multiplier in an open economy. …” |