 Theoretical Framework:

In context of the above information in regards to the ongoing Trade war at global scale,
we would be looking at following two macroeconomic questions:
1. How are the continuous changes in Nx (Net exports) impacting the Output(Y, GDP
(Nominal)) in three largest economies of the world?
2. How will the shifting Balance of Payments and US debt to China impact the foreign
exchange rate between both countries?

GDP Studies in Trade War:

Equation: Y = C+I+G+Nx (Consumption, Investment, Government Expenditure, Net

Exports)

Now, at macroeconomic equilibrium, Aggregate Demand = Aggregate Supply(Y)

Hence, Aggregate demand = Autonomous Demand + c (1-t) Y-bi+Nx(Y, Yf, R), where,
Autonomous Demand = Sum of Consumption, Investment, Government Expenditure and
transfer payments that is not effected by the level of income in the economy, c= Marginal
propensity to consume, t= tax rate, Y= Level of output or income in the domestic
economy, I = interest rate, Nx= Net exports, Yf= Foreign Income, R= Real exchange rate

In simple terms,

IS = Y = DS(Y, i) + Nx(Y, Yf, R), where DS(Y,i) is Domestic Spending impacted by

level of output and interest rate and Nx(Y,Yf,R) is the impact of net balance of trade on
GDP which is impacted by level of domestic income, foreign income and real exchange
rate.

Now, we aim to keep DS(Y, i) constant and study the impact of Nx(Y, Yf, R) on GDP for
discussion on by individually analyzing the impact of components- Yf, R on Y

1. Yf – Foreign Income, Increasing this component leads to the increase in trade

balance of the country hence increasing the Nx thus increasing the Aggregate
demand which under macroeconomic equilibrium is equal to the Aggregate
supply i.e. level of output or income in the economy (Y)
2. R – Real Exchange Rate, It is a ratio of price of a product in terms of domestic
currency value in foreign country to that of the same product in the local
country i.e. R= e (Pf/P). Now, if we decrease the domestic price of the
product the demand of our product will increase in the foreign economies
gradually increasing the domestic price to its global equivalent level and
edging the R to 1. Alternatively, due to huge demand of our product, our
currency’s value will appreciate on the foreign exchange market. Thus, again
edging the real exchange rate to 1. A decrease in real exchange rate will lead
to currency devaluation (rightward shift of LM) hence making our products
cheaper, increasing our exports and thus increasing the trade balance and
consequently increasing the level of output(Y).
 Bibliography:
1. https://www.thebalance.com/trade-wars-definition-how-it-affects-you-4159973
2. https://www.thebalance.com/world-s-largest-economy-3306044
3. The National Bureau of Economic Research. "The Impact of the 2018 Trade War on
U.S. Prices and Welfare." Accessed Dec. 6, 2019.
4. CNN Business. "EU and Japan Sign Trade Deal Covering a Third of the World's
Economy." Accessed Dec. 6, 2019.
5. The New York Times. "Troubles for Ford, G.M. and Fiat Chrysler Send Shares
Diving," Accessed Dec. 6, 2019.
6. https://www.economics.utoronto.ca/jfloyd/modules/xrov.html
7. www.economicsdiscussion.net/foreign-exchange-rate-2/effects-of-depreciation-and-
devaluation-of-the-exchange-rate/10855
8.