In a two country model, an increase in foreign country's national income generally leads to:
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1 mark, −0.333MacroeconomicsKeynesian cross and the multiplierThe open-economy multiplierEasyabout 1 min
GATE 2021 Question 12: Keynesian cross and the multiplier
Answer and worked solution
Answer: (A)
A rise in the foreign country's national income raises foreign residents' overall demand for goods, including goods imported from the home country — this directly increases the home country's exports ( depends positively on foreign income, ).
Since exports are a component of domestic aggregate demand (), higher exports increase domestic output as well, through the standard open-economy multiplier mechanism (this is the basis for how business cycles can transmit across trading-partner countries).
Therefore the answer is (A): increased exports and increased domestic output.
The trap: (D) increased exports but decreased domestic output
This is a fairly direct application of open-economy income transmission, so the main risk is a student second-guessing the intuitive, correct direction and overthinking the relationship — there's no strong conceptual trap here, mostly a test of whether the student correctly recalls that exports depend positively on FOREIGN (not domestic) income.
Keynesian cross and the multiplier has come up 167 times in 7 exams since 2006.
What this question tests
This question is on The open-economy multiplier, part of Keynesian cross and the multiplier in Macroeconomics.
How imports leak spending abroad and shrink the multiplier.
TestStop has 16 past-paper questions on this subtopic.
Question from the GATE 2021 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.