Foreign Trade and National Income

Abstract

One of Keynes’s main contributions to economic theory was to describe how equilibrium in national income is created. As most students are familiar with the determination of national income in a closed economy, we will directly treat the case of an open economy. As with the closed economy model, a central assumption is that prices do not change. This is a reasonable assumption if there are unemployed resources, particularly in the short run. We shall also assume that the exchange rate is fixed, so that there is no balance-of-payments adjustment via exchange-rate changes.