What is the marginal propensity to import when M = 60 + 0.06Y? What is the relationship between the marginal propensity to import and the aggregate demand function?
The marginal propensity to import is 0.06.
In the import function M = 60 + 0.06Y, the coefficient of Y (0.06) represents the marginal propensity to import. It indicates the fraction of an extra rupee of income that is spent on imports.
Regarding the relationship with the aggregate demand function, the marginal propensity to import appears as a negative component (-mY) in the aggregate demand equation. In an open economy, the aggregate demand is given by Y = Ā + cY - mY. Since imports reduce the demand for domestic goods, a higher marginal propensity to import results in a smaller multiplier effect. The open economy multiplier becomes 1/(1 - c + m), which is smaller than the closed economy multiplier because m > 0.
Explanation
The question has two parts. First, identifying the marginal propensity to import from the given equation M = 60 + 0.06Y. Comparing this with the standard form M = M̄ + mY from the textbook, we can see that m = 0.06. Second, the relationship with aggregate demand is explained through the equilibrium income equation Y = Ā + cY - mY, where the marginal propensity to import reduces aggregate demand for domestic output and results in a smaller multiplier compared to a closed economy.
Solution Steps
Step 1: Compare M = 60 + 0.06Y with the standard import function M = M̄ + mY
Step 2: Identify that the coefficient of Y (0.06) is the marginal propensity to import
Step 3: Explain that in the aggregate demand function Y = Ā + cY - mY, the term -mY represents the reduction in domestic demand due to imports
Step 4: Note that since m > 0, the open economy multiplier 1/(1 - c + m) is smaller than the closed economy multiplier