What is the marginal propensity to import when M = 60 + 0.06Y? What is the relationship between the marginal propensity to import and the aggregate demand function?
Marginal propensity to import is the change in import induced by change in income of the country. It is the degree to which country changes its import in relation to change in GDP.
M = 60 + 0.06Y
It means marginal propensity to import is 0.06 which reflects that with 1 Rupee increase in income the import will increase with 0.06.
The marginal propensity to import affects the aggregate demand function negatively. With increase in income the aggregate demand decreases because additional income is spent on foreign goods and not on domestic products.
Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2. Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods). (Hint: First find out the nominal exchange rate as a price of yen in rupees).