Price Changes and the Stability of the Balance of Trade

Abstract

It has been a customary feature of balance of trade analysis for many years to regard the effects on income of a change in the balance of trade to be such that the final equilibrium level of the balance of trade will differ from the original level by less than the amount of the initial change. In this sense the multiplier effects of a change in the balance are stabilising ; that is to say, the multiplier effects of the change in the balance tend to eliminate part of the initial change, rather than magnify it (though it is possible for investment to be related to income in such a way that the situation is unstable ). The object of this note is to show how the relaxation of the customary rigid ' multiplier ' assumption that all prices remain unchanged 12 involves fundamental modifications and additions to the stability conditions which are normally found in the multiplier approach to balance of trade analysis. The introduction of price changes into the determination of the foreign trade multiplier may, in some cases, introduce stability or instability in what would otherwise be unstable or stable situations respectively.3 If it is assumed that prices change as income changes, then the effect of a rise in export prices on the value of exports depends on the elasticity of demand for exports. If the demand is inelastic the value of exports will increase if a rise in income causes a rise in export prices. On the side of imports, there will be, in addition to the change in imports due solely to the change in income, a substitution effect as home prices change relatively to import prices.