Absorption identity
Y = C + I + (X - M)
A = C + I B = X - M
Y = A + B so Y - A = B
At full employment: dB = -dA
Any question about whether a depreciation will work, and any question that gives you output and spending rather than exports and imports.
- Y
- Real national production or income
- A
- Domestic absorption, C + I, everything the nation itself uses up
- B
- The foreign balance or trade balance, X - M
Net improvement in the trade balance with slack
net dB = gross shift in (X - M) - MPM x dY
Equivalently dB = dY - dA
A nation below full employment. Use the first line when the question gives you a gross shift and an MPM, the second when it gives you output and absorption changes.
- gross shift
- The upward shift of the X - M function from the depreciation alone, before income effects
- MPM x dY
- The induced imports pulled in by the extra production, which erode the gross gain
Required fall in absorption at full employment
required fall in A = size of the deficit
covered by: automatic effects + contractionary policy
Whenever the question says full employment. Output is fixed, so the deficit and the required cut in absorption are the same number.
- automatic effects
- The five forces: wage-to-profit redistribution, lower real expenditure, real balance effect, money illusion, higher tax brackets
- contractionary policy
- The remainder, which fiscal and monetary policy must supply