Question

1. How is the IS curve altered by introducing international trade? What is the effect on IS curve of a rise in international trade?                                              

Answer 1

IS curve basically shows the goods market equilibrium where every combination of the interest rate and real GDP on the curve represents a goods market equilibrium. For a closed economy that is not open for international trade, this reflects a situation where AE is the sum of consumption government expenditure and investment. This implies that saving = investment.

When the international trade is initiated by the economy IS curve gets flatter, because it is now reflecting a situation where AE is the sum of consumption government expenditure investment and net exports. This implies that saving - investment = current account balance or net capital outflow.