The net export effect explains how a change in the relative price levels of two countries affects trade and a country’s RGDP.
Net exports equals exports minus imports. A change in the price levels of two countries impacts their trade and net exports. The extent depends on the relative change in both countries. An increase in the price level reduces a country’s aggregate quantity demanded. Suppose the price level in the United States increases more than in Japan, which means the US dollar will become more valuable relative to the Japanese yen. US manufactured goods would become relatively more expensive than Japanese goods.
First, US exports would decrease. Some Japanese buyers would seek substitute goods manufactured in Japan (or another country) rather than import them from the US.
Second, the demand for imports changes. As the price level increases, imports become more attractive because foreign-made goods become relatively less expensive. US consumers would purchase more Japanese products if the US price level increased relative to Japan.
An increase in the price level reduces exports and increases imports, both of which reduce net exports and RGDP. Likewise, RGDP increases when the price level falls because exports would increase and imports would decrease.
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