Net Export Function - Macroeconomics | Macro Economics - B Com PDF Download

Net Export Function

Net export is the difference between exports and imports. Export function is autonomous as it depends upon spending decision made by foreign consumers or overseas firms that purchase domestic goods and services, and thus do not change with change in domestic level of income. Exports are determined by influences outside of the home economy like

The prices of goods in the domestic economy relative to the prices of its substitute goods in other economics.

Tariff and trade policies existing between the domestic and other economies.

The level of income in other countries.

 So this is an autonomous spending from the point of view of the determination of domestic GDP. Export function is shown as a horizontal straight line with reference to real GDP.

The volume of imports is closely related to the condition within the domestic economy. It depends on the spending decisions of domestic residents. Thus import rises when other categories of spending rise with increase in income. So it depends upon the economic condition and income level of an economy. The level of income within the domestic territory is the most important factor influencing the level of imports keeping other factors like unchanging tariff, trade and exchange restrictions, unchanging system of international price differences etc. All else being equal, as the level of income rises, we expect an induced rise in spending, some portion of which will lead to rise in spending on imported goods and services by households and also manufacturing firms buy or import more capital goods and raw materials when the industrial output expands. There can be a linear relationship between income and imports which can be expressed as

M=Ma+mY Where Ma represents autonomous imports i.e. imports at zero level of income and mY is the induced imports i.e. increase in import because of increase in income. m denotes Marginal propensity to import i.e. MPM which is equal to change in imports/change in income.

As a result Net export which represents the difference between X and M is negatively related to the level of GDP as when increasing value of imports are deducted from constant value of export we will get decreasing values of net exports in relation to increasing GDP. Net export function studies the functional relationship between net exports and level of GDP. That is

X-M=f(Y)

As real GDP increase from 0 to1500, net exports decreases from 40 to -110. At GDP level 400, Net export is equal to zero. That is export earnings of the company are just equal to import expenditure.Net exports are positive at low level of income and negative at high levels of GDP.

At zero GDP level, export is OA=60 and import is zero. Net Export is OA-0=OA1=40. In panel B at zero income level, net export is OA1. At income level OY1, exports exceeds import by KH=20 in panel A. At this income level net exports is DC=KH. The break even income level is OY where exports=imports=BY=60, thus net export is zero at point G in Panel B. At OY2 income level imports exceed exports by TS=80 so negative net exports to the extent of EF is equal to TS in panel A. By joining points A1, D, G and F we get the net export function. It is a downward sloping line indicating the negative relationship between net exports and real GDP, keeping factors other than national income that affect net export function constant.

Change in the net export function

A change in net export function occurs when we move from one point to other along with the net export function. This change occurs due to a change in real GDP. Forward movement along the net export function occurs due to an increase in real GDP like from D to G in the following diagram because of increase in real GDP from 200 to 400. And backward movement occurs due to a decrease in GDP like from E to G in the following diagram because of decrease in real GDP from 800 to 400. Net export reduces if there if there is backward movement along the net export function. This is due to the negative relationship between net exports and GDP as increase in income leads to increase in imports keeping exports constant so net export decreases.

Shifts in Net Export Function

At a particular level of GDP, if net export increases or decreases due to favorable or unfavorable changes in the factors affecting it, the net export line shifts upward or downward. The Unfavorable changes cause a backward shift of the net export function. Favorable changes in the factors cause an upward shift. Such shifts may or may not be parallel to the initial net export function. It depends on the marginal propensity to import along with the net exports functions at different level of GDP. If MPM remains same then parallel shifts will be there but if MPM changes then non parallel shifts will be there.

Factors causing shifts in Net Export Functions

Factors other than real GDP are

1. Foreign real national income: Any change in real national income of the foreign countries directly affects the net exports of domestic economy as when foreign GDP increases, foreign demand for goods increases due to which exports of domestic economy increases. This lead to parallel upward shift in net export function as same additional amount is sold at each level of domestic GDP. The increase is in the constant of domestic net exports and m remains constant. For example when there is high growth in GDP in the United States, it will import more goods and services from India. As a result exports in India increases and will affect its net export function also.
2. Relative International Price Level: Relative prices of domestic goods and services determine competitiveness of the domestic economy. Changes in international price level in relation to the domestic price level will be there because of two reasons Inflation rate and Exchange rate, cause net export function to shift. It affects both X and M of the domestic economy. When due to high inflation rate in domestic economy, price level in domestic economy rises relative to the international price level, domestic goods become costlier and foreign goods become cheaper which leads to reduction in the export of domestic goods as foreign demand decreases and increase in imports as demand for cheaper foreign goods increases in domestic economy. Thus net exports function shifts down. Non parallel shift will be there as MPM changes because of change in relative price level. For example, suppose inflation rate in India is higher than in China. This causes relative prices of Indian goods higher than those of the China and therefore adversely affect our competitiveness as our goods become expensive as compared to foreign goods, because of which our exports falls and imports rises thus net exports shift down. On the contrary net export increases if domestic price level falls in relation to the international price level.
3. Exchange rate: It is the rate at which currency of one country is exchanged for currency of other country. In the flexible exchange rate system, exchange rate fluctuates because of change in demand and supply of currencies. This fluctuation in exchange rate affect net export function of an economy like an appreciation of the value of home currency in terms of foreign currency like value of Indian Rupee rises from Rs 47 to a dollar to Rs 45 to a dollar, means foreign demand for domestic currency is more than its supply. It makes domestic goods costlier in comparison to foreign goods which in turn leads to reduce the exports and increase the imports of domestic economy which ultimately reduces its net export.

Parallel shifts

If MPM remains constant, then because of change in exports, new net export function will be parallel to the initial one. As the slope of two net exports functions remains the same. 

Non parallel shifts

The non parallel shifts occur due to change in MPM. Due to unfavorable changes such as increase in price level in the domestic economy, decrease in GDP of other economies, net export function shifts backward which shows lower level of net exports as compared to the initial one. It will be steeper also as MPM increases along with downward shift in the net export function.

On the other hand due to favorable changes such as decrease in price level in the domestic economy, increase in GDP of other economies, net export function shifts forward showing high level of exports and flatter as MPM falls with upward shift in the net export function.

So it is because of change in MPM the slope of net export function changes. Increase in MPM cause net export function steeper and decrease in MPM cause it flatter.