Policies to correct disequilibrium in the balance of payments · A Level Economics

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Consider the extent to which a depreciation of the yen has been beneficial for Japan’s balance of trade in goods and services. Evidence from the article about its benefits:

• It encourages export sales despite relatively low global economic growth

(1) due to lower prices of exports (1)

• Lower global incomes could be offset by lower prices of Japanese products (1)

• The number of foreign visitors to Japan has also increased due to the weak yen (1). Now cheaper for foreign tourists to visit and spend in Japan

(1)

• In contrast, the article says:

• the yen needed to be strengthened to restore investor confidence and reduce imported inflation (1). Explanation on how investor confidence could improve Japan’s balance of trade (1)

• Credit reference to the price elasticity of demand (PED) for Imports and Exports (1) NOTE: Maximum 4 marks if no contrast

Explain why a balance of trade deficit might be regarded as undesirable by the US government. Implies that (X-M) worsens and therefore Job losses 1 Reduction in gross domestic product (GDP) 1 Imported inflation 1 Fall in foreign exchange reserves. 1

Max 2

Explain, with the aid of a diagram, how import tariffs lead to expenditure switching in the US economy. Price US Demand US supply P1 B P2 F G World Supply+Tariff P3 world supply Q1 Q2 Qe Q3 Q4 Quantity

Diagram Axes and Labels 1 + 1 (Axes MUST show world supply)

Max 2 for diagram Comments based on diagram Max 2 Imports reduce (Q1 to Q4) to (Q2 to Q3) 1 Domestic output increases Q1 to Q2 1 World supply falls from Q4 to Q3 1 Explanation 1 developed point 1 + 1 2 points 1 and 1

Discuss whether expenditure-reducing policies are preferable to expenditure-switching policies in order to correct a persistent deficit on the current account of the balance of payments.

Use Table A: AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Explanation of how a persistent deficit on the current account of the balance of payments may occur, with reference to its components.

• Explanation and analysis of how a contractionary fiscal/monetary policy ‘reduces expenditure’ by reducing aggregate demand/incomes and therefore imports.

• An AD/AS diagram may be analysed.

• An exchange rate diagram, to explain how a fixed/managed exchange rate can be devalued.

• Explanation and analysis of how a devaluation of an exchange rate ‘switches expenditure’ from imports to exports.

• Explanation and analysis of how protectionist policies e.g. tariffs, subsidies on exports, productivity increasing supply-side policy ‘switch expenditure’ from imports to domestically produced goods.

AO3 Evaluation

• Expenditure-reducing policies will reduce real GDP and may cause a rise in unemployment.

• Demand for imports may continue to be high if they are essential as inputs for manufacturing or necessities,

• An analysis of how the deficit might widen after a devaluation if the Marshall-Lerner condition is not fulfilled. ‘J’ curve analysis.

• Other economies may also devalue their exchange rates.

• Effect of devaluation on the price of imports may raise costs of production and consumer prices, which may also lead to lower exports.

• Protectionist policies e.g. tariffs may lead to retaliation/cause a trade war/ be against World Trade Organisation rules/Net welfare loss.

• In the long run, supply side policies to improve exports may be preferable to both expenditure-switching and expenditure-reducing policies.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

The use of tariffs is the most effective way to correct a balance of payments deficit. With the help of a diagram, evaluate this statement

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Tariffs should be clearly explained as a tax on selected imports and such taxes will act as a barrier to free trade

• The key elements of the balance of payments accounts should be briefly outlined

• A balance of payments deficit should be explained and linked to its potential effects on a country’s exchange rate.

• An accurate, clearly labelled diagram should be provided which would form the basis for analysing the impact of a tariff on the balance of payments.

• The focus of the analysis should be on the recognition that tariffs represent an expenditure switching policy which will rely significantly upon the response of the demand for imports in relation to a change in the price of imports.

• Also, the analysis should recognize the overall impact of an increase in tariffs will be primarily upon the goods and services element of the balance of payments current account. No diagram Max L3–Micro diagram not acceptable

AO3 Evaluation

• Tariffs often produce a retaliation response by those countries which have to pay the tariff. This might significantly reduce the positive impact upon the balance of payments.

• The benefits of imposing a tariff regarding a balance of payments deficit will also be determined by the nature of the balance of payments deficit. Although tariffs might be suitable for a long-term, persistent deficit, alternative policies might be more effective for short-term, more temporary situations.

• Alternative methods of addressing the balance of payments deficit may be more appropriate. For example, an economy experience high inflation might use a more effective expenditure reducing policy to correct this deficit.

• The net effect on the current account will also be determined by the elasticity of demand for imports. Imports which are deemed inelastic will increase, rather than reduce total expenditure on imports when the price of imports rises.

• Other potential negative effects on the economy also need to be considered. For example, the loss of producer and consumer surplus.

• A conclusion might attempt to form an overall judgement on the short term and long-term impact on the balance of payments.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

With the help of a diagram, evaluate the effectiveness of the use of expenditure-switchingpolicies to reduce a currentaccount deficiton the balance of payments. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2Analysis

• An explanation of the meaning of a current account balance of payments deficit should be provided.

• Expenditure-switching policies should be explained by the relationship between changes in the market prices of imported and exported goods and services and changes in the balance of payments current account

• Examples of expenditure-switching policies such as a decrease in tariffs or a devaluation of a currency in a fixed exchange rate system.

• Analysis of the impact of the introduction of a tariff on the balance of payments current account. An accurately labelled diagram should be provided.

• Analysis of the impact of tariffs on other key stakeholders, for example, domestic suppliers, consumers and firms should be considered.

• Analysis of the use of an alternative expenditure switching policy should be provided. For example, the use of a devaluation in a fixed exchange rate system. Accept export subsidies/supply side policies.

L2 max if no relevant diagram provided.

AO3 Evaluation

• It is important to establish the magnitude of the deficit and the how long this deficit has persisted before interfering in the import/export market.

• Although tariffs might temporarily reduce the deficit,other countries might introduce their own tariffs in retaliation.

• Tariffs might have a negative impact on other key macroeconomic variables. For example, tariffs might contribute to a growth in cost push inflation

• Tariffs might lead to a net welfare loss for society as a whole. This can be shown on a clearly labelled diagram.

• A devaluation of the currency will depend upon the relative price elasticities of supply/demand for imports and exports. The Marshall- Lerner condition should be explained.

• A devaluation might also have a negative impact on other key macroeconomic variables. For example, a devaluation will stimulate the demand for exports, which might contribute to demand pull inflation. Or contribute to cost push inflation by raising the price of imported goods

• A conclusion addressing the specific statement should be provided.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation