Question

Consider the formula GDP=C+I+G+(X-M). A country is undergoing a boom in consumption of domestic and foreign luxury goods. In one year, the dollar growth in imports is greater than the dollar growth in domestic consumption. Assuming nothing else has changed, what happened to GDP?

a) Increased
b) Decreased
c) Unchanged
d) Cannot be determined from the information provided

Answer 1

Assuming all other factors remain constant and the growth in imports exceeds the growth in domestic consumption, the GDP of the country would decrease due to the negative impact on the net export component of the GDP calculation.

Step-by-step explanation:

When considering the equation GDP = C + I + G + (X - M), where GDP stands for Gross Domestic Product, C is consumption, I is investment, G is government spending, and (X - M) is the net exports (exports minus imports), several components of the economy are taken into account. If a country experiences a boom in consumption, this would naturally increase the GDP. However, if during the same period, the dollar growth in imports is greater than the dollar growth in domestic consumption, then the net export component (X - M) would be negative, and larger in absolute value than before, assuming no changes in other components.

Because the GDP formula subtracts imports from exports, an increase in imports (without a corresponding increase in exports) will decrease this part of the calculation. Therefore, if the increase in consumption does not offset the increase in imports, the overall GDP decreases. In this specific scenario, assuming all else is constant, the increase in imports more than the rise in consumption would lead to a reduction in GDP.