# Australian investment - Fixed Exchange Rate System

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Refer to graph attached.

1. Starting at equilibrium income $50 billion, where (S - I)0 intersects (X - M) 0, suppose that worsening economic conditions abroad lead to an autonomous decrease in Australian exports of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

2. Starting at equilibrium income $50 billion, where (S - I) 0 intersects (X - M) 0, suppose that improving profit expectations lead to an autonomous increase in Australian investment of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

3. Starting at equilibrium income $50 billion, where (S - I) 0 intersects (X - M) 0, suppose that increased thriftiness leads to an autonomous increase in Australian saving of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

4. Starting at equilibrium income $50 billion, where (S - I) 0 intersects (X - M) 0, suppose that changing preferences lead to an autonomous increase in Australian imports of $5 billion. How much will Australian income be? What will Australia's trade account balance be? Explain your reasoning.

5. As indicated by the slope of the (X - M) schedule and (S - I) schedule, what is the value of Australia's foreign trade multiplier?

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#### Solution Preview

Question 1

If there is an autonomous decrease in Australian exports (X), this means that the (X-M) schedule must move down, because now net exports will be lower for any income level. The (S-I) schedule wil remain unchanged.

So basically, what happens here is that (S-I) remain at (S-I)0, while (X-M) moves to (X-M)2 (notice that (X-M)2 is exactly the same as (X-M)0 minus 5 billion, which is the amount by which exports fall).

Looking at where the intersection between these lines happen, we conclude that income will fall to $40 billion and there will be a trade balance (X-M) deficit of -2.5 billion. The result is then that the Australian economy will enter a recession (because its aggregate demand -specifically, its exports component- falls) and will run a trade deficit, as a result lower exports.

Question 2

If there is an autonomous increase in Australian investment (I) of 5 billion, we can expect the (S-I) schedule to fall by 5 billion. (S-I) will be 5 billion lower for any income level, so its schedule will shift down. The (X-M) schedule remains unchanged, and the (S-I) schedule will move from (S-I)0 to (S-I)1.

We conclude then that the new income level will ...

#### Solution Summary

Australian investment is assessed in these problems.