Question

In a two country model, an increase in foreign country’s national income generally leads to:

• A. increased exports and increased domestic output
• B. decreased exports but increased domestic output
• C. decreased exports and decreased domestic output
• D. increased exports but decreased domestic output

Hint:

When foreign income rises, it usually increases demand for exports, leading to increased production in the home country.

Answer 1

The Correct Option is A

Step 1: Understand the effect of foreign income on exports.
When the foreign country’s national income increases, its demand for goods and services (including imports) generally increases, which boosts the exports of the home country. Additionally, increased exports lead to a rise in domestic output as production is ramped up to meet the demand.
Step 2: Evaluate the options.
- (A) Increased exports and increased domestic output: As the foreign country’s income rises, there is more demand for the home country’s exports, leading to increased output in the domestic economy to satisfy this demand.
- (B) Decreased exports but increased domestic output: This is unlikely, as an increase in foreign income would generally lead to more exports, not fewer.
- (C) Decreased exports and decreased domestic output: This is contrary to the general economic theory, where increased foreign income leads to an increase in both exports and domestic output.
- (D) Increased exports but decreased domestic output: While exports might increase, it is unlikely that domestic output would decrease; instead, output should rise with increased demand.
Step 3: Conclusion.
The correct answer is (A), as increased foreign income leads to both increased exports and increased domestic output. Final Answer: (A) increased exports and increased domestic output