Page 1
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Paper: International Economics
Lesson: Devaluation and its Theories
Author: Sarbjeet Kaur
College/Department: Rajdhani College
Page 2
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Paper: International Economics
Lesson: Devaluation and its Theories
Author: Sarbjeet Kaur
College/Department: Rajdhani College
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Table of the Contents
Chapter: Devaluation and its Theories
1. Foreign Trade Multiplier
1.1 Foreign Repercussions
2. Devaluation
2.1 objectives of devaluation
2.2 merits of devaluation
2.3 demerits of devaluation
2.4 Approaches of Devaluation
2.4.1 Elasticity Approach
2.4.1.1Marshal-Learner Condition
2.4.2 Absorption Approach
3. Exercise
4. References
Page 3
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Paper: International Economics
Lesson: Devaluation and its Theories
Author: Sarbjeet Kaur
College/Department: Rajdhani College
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Table of the Contents
Chapter: Devaluation and its Theories
1. Foreign Trade Multiplier
1.1 Foreign Repercussions
2. Devaluation
2.1 objectives of devaluation
2.2 merits of devaluation
2.3 demerits of devaluation
2.4 Approaches of Devaluation
2.4.1 Elasticity Approach
2.4.1.1Marshal-Learner Condition
2.4.2 Absorption Approach
3. Exercise
4. References
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Foreign Trade Multiplier
Multiplier is a principal conception in economics, which study how the
economic direction changes due to the changes in different factors. For
instance, investment explains the change in equilibrium level of income and
consumption due to changes in the level of investment. It explains as the
level of investment increases with an increase in marginal propensity to
consume(MPC), i.e. consumption is directly related with investment in two
sector model. The FTM works like Keynesian multiplier. It can be defined as
the change in national income due to changes in domestic investment on
exports. The FTM works in four sector model
of the economy or open economy.FTM is
also called as export multiplier.
With the increase in exports, there is an
increase in aggregate demand (directly or
indirectly), i.e. with an increase in exports,
there is an increase in the domestic
production in the foreign market; hence,
there will be a boom in the industries and
also employment opportunities will increase.
Further, it will increase in the demand of the
consumers and hence aggregate demand in
the economy, this is called as the foreign
trade multiplier effect. Therefore, FTM changes national income due to
changes in investment and changes in exports. Hence, FTM is dependent
upon two factors, a) MPS and b) MPM. Smaller the propensities, larger will
be the value of multiplier and vice versa.
Box 1
The foreign trade
multiplier also known
as the
export multiplier
operates like the
investment multiplier
of Keynes. It may
be defined as the
amount by which the
national income of a
nation will be raised by
a unit increase in
domestic investment
Page 4
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Paper: International Economics
Lesson: Devaluation and its Theories
Author: Sarbjeet Kaur
College/Department: Rajdhani College
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Table of the Contents
Chapter: Devaluation and its Theories
1. Foreign Trade Multiplier
1.1 Foreign Repercussions
2. Devaluation
2.1 objectives of devaluation
2.2 merits of devaluation
2.3 demerits of devaluation
2.4 Approaches of Devaluation
2.4.1 Elasticity Approach
2.4.1.1Marshal-Learner Condition
2.4.2 Absorption Approach
3. Exercise
4. References
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Foreign Trade Multiplier
Multiplier is a principal conception in economics, which study how the
economic direction changes due to the changes in different factors. For
instance, investment explains the change in equilibrium level of income and
consumption due to changes in the level of investment. It explains as the
level of investment increases with an increase in marginal propensity to
consume(MPC), i.e. consumption is directly related with investment in two
sector model. The FTM works like Keynesian multiplier. It can be defined as
the change in national income due to changes in domestic investment on
exports. The FTM works in four sector model
of the economy or open economy.FTM is
also called as export multiplier.
With the increase in exports, there is an
increase in aggregate demand (directly or
indirectly), i.e. with an increase in exports,
there is an increase in the domestic
production in the foreign market; hence,
there will be a boom in the industries and
also employment opportunities will increase.
Further, it will increase in the demand of the
consumers and hence aggregate demand in
the economy, this is called as the foreign
trade multiplier effect. Therefore, FTM changes national income due to
changes in investment and changes in exports. Hence, FTM is dependent
upon two factors, a) MPS and b) MPM. Smaller the propensities, larger will
be the value of multiplier and vice versa.
Box 1
The foreign trade
multiplier also known
as the
export multiplier
operates like the
investment multiplier
of Keynes. It may
be defined as the
amount by which the
national income of a
nation will be raised by
a unit increase in
domestic investment
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
1) MPS: It refers to increase in savings due to increase in national
income. With the increase in exports, there is an increase in income.
Hence, savings will increase because of increase in income, which will
create negative impact. Because, savings is considering as a leakage
in national income with the increase in income, if consumption
increases (i.e. MPC increases), this creates the multiplier effect, hence
there is a negative relation between increase in MPS and export
multiplier.
2) MPM: As savings, imports are also leakage from the economy. With an
increase in imports, there is a decrease in domestic wealth and hence
national income; therefore, there is a negative relation between MPM
and export multiplier.
According to investment and saving approach, equilibrium level of national
income is given by
change in injections= changes in leakages
In four sector model,
?I +?X= ?S + ?M.
?S= MPS. ?Y.
?I + ?X= MPS (?Y) + (MPM). ?Y
?I + ?X= (MPS+MPM) ?Y.
?Y=
1
???????????? + ???????????? (?I + ?X)
Hence k’=
?Y
?I+ ?X
=
1
???????????? + ????????????
Where k’ is FTM.
Page 5
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Paper: International Economics
Lesson: Devaluation and its Theories
Author: Sarbjeet Kaur
College/Department: Rajdhani College
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Table of the Contents
Chapter: Devaluation and its Theories
1. Foreign Trade Multiplier
1.1 Foreign Repercussions
2. Devaluation
2.1 objectives of devaluation
2.2 merits of devaluation
2.3 demerits of devaluation
2.4 Approaches of Devaluation
2.4.1 Elasticity Approach
2.4.1.1Marshal-Learner Condition
2.4.2 Absorption Approach
3. Exercise
4. References
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Foreign Trade Multiplier
Multiplier is a principal conception in economics, which study how the
economic direction changes due to the changes in different factors. For
instance, investment explains the change in equilibrium level of income and
consumption due to changes in the level of investment. It explains as the
level of investment increases with an increase in marginal propensity to
consume(MPC), i.e. consumption is directly related with investment in two
sector model. The FTM works like Keynesian multiplier. It can be defined as
the change in national income due to changes in domestic investment on
exports. The FTM works in four sector model
of the economy or open economy.FTM is
also called as export multiplier.
With the increase in exports, there is an
increase in aggregate demand (directly or
indirectly), i.e. with an increase in exports,
there is an increase in the domestic
production in the foreign market; hence,
there will be a boom in the industries and
also employment opportunities will increase.
Further, it will increase in the demand of the
consumers and hence aggregate demand in
the economy, this is called as the foreign
trade multiplier effect. Therefore, FTM changes national income due to
changes in investment and changes in exports. Hence, FTM is dependent
upon two factors, a) MPS and b) MPM. Smaller the propensities, larger will
be the value of multiplier and vice versa.
Box 1
The foreign trade
multiplier also known
as the
export multiplier
operates like the
investment multiplier
of Keynes. It may
be defined as the
amount by which the
national income of a
nation will be raised by
a unit increase in
domestic investment
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
1) MPS: It refers to increase in savings due to increase in national
income. With the increase in exports, there is an increase in income.
Hence, savings will increase because of increase in income, which will
create negative impact. Because, savings is considering as a leakage
in national income with the increase in income, if consumption
increases (i.e. MPC increases), this creates the multiplier effect, hence
there is a negative relation between increase in MPS and export
multiplier.
2) MPM: As savings, imports are also leakage from the economy. With an
increase in imports, there is a decrease in domestic wealth and hence
national income; therefore, there is a negative relation between MPM
and export multiplier.
According to investment and saving approach, equilibrium level of national
income is given by
change in injections= changes in leakages
In four sector model,
?I +?X= ?S + ?M.
?S= MPS. ?Y.
?I + ?X= MPS (?Y) + (MPM). ?Y
?I + ?X= (MPS+MPM) ?Y.
?Y=
1
???????????? + ???????????? (?I + ?X)
Hence k’=
?Y
?I+ ?X
=
1
???????????? + ????????????
Where k’ is FTM.
Devaluation and its Theories
Institute of Life Long Learning, University of Delhi
Hence, FTM shows that there is a negative relation between multiplier, MPM
and MPS, i.e., the value of multiplier decreases with an increase in MPS and
MPM, on the other hand, the value of multiplier increases with an increase in
export and investment.
Foreign Repercussions
In this section, assumption that the nation is small is relaxed and foreign
trade multiplier is extended with foreign repercussion. Foreign trade is done
by two countries; one by the domestic country and the other by trading
partner. An increase in exports of domestic country arises from and is equal
to the increase in imports of foreign country. If this increase in the imports
of foreign country replaces domestic production then the income of domestic
nation decreases. As the income falls, which will decrease in the imports of
the foreign country, this represents a foreign repercussion domestic country
that neutralizes part of an original increase in its exports. This will further
decrease the value of foreign trade multiplier of domestic country (i.e.
exporting country), hence, foreign trade multiplier without repercussions is
greater than foreign trade multiplier with repercussion. Hence, the trade
balance of exporting country will not improve much.
Formula of computation for the value of FTM with foreign repercussions for
an increase in exports is given as:
???? '
???? =
1
???????????? 1
+ ???????????? 1
+ ???????????? 2
(
???????????? 1
???????????? 2
? )
Where the subscripts 1 and 2 refers to domestic country and foreign
country respectively. For example, if MPS
1
= 0.25, and MPM
1
=0.15 for
domestic country and MPS
2
= 0.2 and MPM
2
= 0.1 for foreign country
then:
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