Describe the process by which equilibrium output in an open economy is decided.
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Describe the process by which equilibrium output in an open economy is decided.
Equilibrium Output in an Open Economy
In an open economy, equilibrium output is determined by the interaction of aggregate demand and aggregate supply, considering the impacts of international trade and capital flows.
Aggregate Demand: In an open economy, aggregate demand (AD) includes not only domestic consumption (C), investment (I), and government spending (G) but also net exports (NX), which is exports minus imports. AD = C + I + G + NX.
Aggregate Supply: Aggregate supply (AS) represents the total output of goods and services that firms in an economy are willing and able to produce at different price levels.
Equilibrium: Equilibrium output is reached at the point where aggregate demand equals aggregate supply (AD = AS). At this point, the goods and services that the economy is producing are exactly equal to the goods and services being consumed domestically and abroad.
Impact of International Trade: In an open economy, changes in global economic conditions, exchange rates, and trade policies can shift the AD curve. For instance, an increase in global demand for a country's exports would shift the AD curve to the right, increasing equilibrium output.
Capital Flows: Capital inflows and outflows can also impact investment (I) in the economy, further influencing aggregate demand and equilibrium output.
In summary, equilibrium output in an open economy is determined by the level of aggregate demand and aggregate supply, with additional influences from international trade dynamics and capital movements.