Our exports (X) are the goods and services produced at home but sold to residents of other countries. Our imports (IM) are goods and services produced in other countries but bought by domestic residents. Exports and imports each amounted to between 30 and 35 percent of GDP in 2013. Net exports \(NX = X − IM\), is the difference between exports and imports, which is the net effect of international trade on aggregate expenditure.
Exports (X): domestic goods and services sold to residents of other countries.
Imports (IM): goods and services bought from other countries.
Net exports (NX): measure the difference between exports and imports.
Canada is a very open economy. In the United States, by comparison, exports and imports make up only 10 to 15 percent of GDP. International trade is much more important to aggregate expenditure in Canada and most European countries than in a very large country with diverse regions like the United States, which trades mostly internally.
Exports are a part of autonomous aggregate expenditure. Canadian exports are not determined by Canadian national income. Instead they depend on income levels in other countries, price levels here and in those countries, and the foreign exchange rate.
The foreign exchange rate is the domestic currency price of a unit of foreign currency. This is the price people pay to buy the U.S. dollars they want to cover travel costs in the U.S. It is also the amount of Canadian dollar revenue a Canadian exporter receives for each $1.00U.S. of exports sales to U.S. buyers. In mid-2012 our exchange rate, the Canadian dollar price of the United States dollar, was about $1.01Cdn/$1.00U.S. In late 2014 our exchange rate was $113.6/$1.00US. Exporter revenues per dollar of sales to the US were about 12 percent higher and imports from the US cost about 12 percent more.
Foreign exchange rate: the domestic currency price of foreign currency.
Assuming that prices and exchange rates are constant, the price competitiveness and profitability of Canadian exports is fixed. Changes in national incomes in export markets will cause changes in our exports. A recession in the United States, for example, reduces demand for Canadian exports of raw materials, energy, and manufactured goods like automobiles, as was the case in 2008 and 2009. Previously, strong growth in U.S. real GDP created strong demand for Canadian exports. Canadian exports to other parts of the world, such as China and India, are driven by GDP and GDP growth in those countries.
However, as we will see in later chapters, changes in economic and financial conditions change exchange rates. The competitiveness and profitability of exports change as a result. In Canada between 2002 and 2007 the exchange rate fell, lowering the Canadian dollar price of the United States dollar from $1.58Cdn to $0.98Cdn for $1.00U.S. A U.S. dollar of sales revenue from exports that provided $1.58 in Canadian dollar revenue in 2002 brought just $0.98 in Canadian dollar revenue in 2007. In the earlier period, 1995 to 2001, the rise in the exchange rate made Canadian exports very competitive and profitable, supporting strong export growth. Subsequently, the fall in the exchange rate caused a difficult market and competitive conditions for manufactured exports.
For now, assuming exchange rates are constant and letting X0 be autonomous exports, the export function is:
\[X = X_0\]
Exports, like investment, can be a volatile component of aggregate expenditure. Changes in economic conditions in other countries, changes in tastes and preferences across countries, changes in trade policies, and the emergence of new national competitors in world markets all impact on the demand for domestic exports. To illustrate this volatility in exports and in investment, Figure 6.6 shows the year-to-year changes in investment, exports, and consumption expenditures in Canada from 1987 to 2012. You can see how changes in investment and exports were much larger than those in consumption. This volatility in investment and exports appears as up and down shifts in the functions in Figures 6.5 and 6.7.
Imports are part of domestic expenditure. Like consumption expenditure, imports rise when national income rises and fall when national income falls. Goods and services bought by households and business are a mix of domestic output and imports. Exports of goods and services embody imported components and services. Some imports are autonomous; that is, independent of current income. Changes in autonomous consumption, investment, and exports include changes in autonomous imports. Some changes in imports are induced by changes in income through the marginal propensity to import \(MPM = m\). The MPM is a positive fraction, reflecting the fact that a rise in income causes an increase in induced expenditure, including induced imports.
Marginal propensity to import \((MPM = m)\): the change in imports caused by a change in national income.
Imports also depend on domestic and foreign prices and the foreign exchange rate. The recent fall in the Canada–United States exchange rate resulted in strong increases in cross-border shopping and travel by Canadian residents. In earlier years the high exchange rate raised prices of imports to Canada. Higher costs in Canadian dollars for U.S. goods, travel, and tourist services reduced cross-border travel by Canadians and imports from the United States.
Using IM0 for autonomous imports and m for the marginal propensity to import (∆IM/∆Y), and assuming constant exchange rates, the import function is:
\[IM = IM_0 + mY\]
Figure 6.7 shows expenditure on exports and imports at different levels of national income. Assume for purposes of illustration that X0 = 100. The export function with a vertical intercept of 100 is a horizontal line because exports are autonomous. Autonomous imports are IM0 = 40 when national income is zero, and rise as national income rises. The slope of the import function is the marginal propensity to import (MPM) with m = 0.2. A change in national income of $1 changes imports by $0.20.
Figure 6.7: Export and Imports
Exports are autonomous at X = 100. Imports increase from an autonomous
level of 40 as income increases, according to the marginal propensity to
import m. Net exports vary inversely with real GDP.
The difference between exports and imports at each level of national income is the net export level. At low income levels, imports are low and net exports are positive. At higher income levels, higher imports result in negative net exports. The marginal propensities to import and consume play very important roles in the operation of the economy through the induced changes in aggregate expenditure they generate.