Forex: Trade Depends on Income
The volume of a nation's imports depends positively on the level of real national product.
Although a nation's expenditures on goods and services are not the same thing as its national income from producing goods and services, the close statistical correlation between income and expenditure has allowed statistical studies to gloss over this distinction when estimating import functions.
The most important parameter of the dependence of imports on income is the marginal propensity to import, which is the ratio of a change in import volumes to the change in real national income causing the import change.
The marginal propensity to import is represented geometrically by the slope of the import function. By linking extra income to extra imports, the marginal propensity to import shows the extent to which extra prosperity spills over into imports, worsening the balance of trade, rather than adding to the domestic multiplier process by becoming a further new demand for domestic goods and services.
Also, it is a 'leakage', from the expenditure stream.
The dependence of exports on national income is more complex. It depends primarily on whether any changes in national income are the result of domestic demand changes, domestic supply changes, or changes in foreign demand for our exports. If domestic national income is raised by a surge in domestic aggregate demand which touches off an expansion of output and/or prices throughout the economy, then there is a good chance that the increase in national income will be accompanied by a drop in export volumes, as domestic buyers bid away resources that might otherwise have been exported.
Although such a negative dependence of export volumes on national-income-as-determined-by-domestic-demand is plausible, the evidence for it is somewhat sparse, and most countries with an open economy assume that export volumes are independent of national income.
Two other outside forces can make export volumes seem to vary positively with national income--- one is a supply-side expansion, or any cost cutting, whether due to productivity improvements or price-cutting institutional changes or any other supply-side shift.
If national income is being expanded under such influences, this expansion will be accompanied by a rise in exports as the price reductions give the country a greater competitive advantage.
Alternatively, the country could be experiencing a surge in foreign demand for its exports, allowing both exports and national income to expand.
On a positive note, imports are often used as inputs into the production of the goods and services that constitute national product, or roughly speaking, national income. The other is that imports respond to the total real spending, or 'absorption', in our economy. The more we spend on all goods and services, the more we tend to spend on the part of them that we buy from abroad.
