Imports of a country, however, depend upon the spending decisions of the domestic residents. Residents of a country often make demand for foreign made goods and services. As the GDP rises, the residents of a country can spend more on the imported goods implying positive relationship between imports and real GDP. Import function may be states as follows:
M = mY
where, m is marginal propensity to import or slope of the import function.
This is shown in fig as an upward rising curve. At ‘O’ income level, import is also zero. As income increase, imports also increase. Line M is the import function. It starts from the origin and increases as income increase. Slope of the import function indicates marginal propensity to import (m). Lower the m, steeper the import function to X-axis and vice-versa.
Net exports refer to the different between exports and imports. Desired net exports are negatively related to GDP because of the positive relationship between desired imports and GDP.
This negative relationship can be easily explained as follows.
Export function (which is an injection to the flow of income) is assumed to be autonomous, and hence a horizontal straight line. Imports increase (this is treated as a withdrawal) as level of real income rises. Obviously, when increasing values of import are deducted from a constant value of exports we will get decreasing values of net exports in relation to increasing level of real income.
At zero income, exports = 50, imports = 0. As real income increase, autonomous exports are assumed to remain constant at 50. Imports increase; marginal propensity to import is assumed to be 0.25. Therefore, the trade surplus fails. As imports keep increasing, M and X become equal when level of income is 200. With a further increase in real income, net exports become negative, i.e. balance of trade turns, negative.
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