ABSTRACT
Our analysis of the balance-of-payments adjustment mechanism has been focused thus far primarily upon the changes in exports and imports that occur in response to automatic or policy-determined changes in relative prices under conditions of full employment of resources. In this full employment context, the price or elasticities approach has the apparent merit of being relatively simple. This simplicity may be deceptive, however, since the home and foreign demand and supply elasticities in question are basically partial in nature and therefore may be subject to change during the process of adjustment. This will be especially the case when the level of real income is permitted to vary. Thus, in itself, the price approach to balance-of-payments adjustment may not suffice. We need as well an approach in which variations in real national income play an important role in the adjustment process. The development and application of the Keynesian theory of national income determination to open economies has furnished us with such an approach. Since both income and prices may be subject to variation in the process of adjustment, the need is evident for both an income approach and a price approach to analyze this process. These approaches are therefore not in conflict, although as we shall see, there may be grounds in certain situations for preferring one or the other.
