Paper 3 Mock exam Flashcards

Question

Give the types of expenditure switching policies

Answer 1

Trade protectionist policies (ie, tariffs, quotas or subsidies) Depreciation (or devaluation) of currency could be used to correct a long-term current account deficit.

Answer 2

Contractionary monetary policy could be used to correct a long-term current account deficit Contractionary fiscal policy could also be used to correct a long-term current account deficit

Answer 3

A free trade area is when there are multiple states that agree to open up free trade between each other by eliminating or reducing the use of tariffs or other trade barriers. A free trade area and custom union work similarly however there is one key difference. All members of a customs union have to follow the same trade protectionist policy.

Answer 4

Increased competition – The removal of trade barriers within trading blocs results in increased competition among producers in member countries. Improved efficiency in production – The elimination of trade barriers and free trade lead to improved efficiency in production, as inefficient producers lose their protection. Lower prices for consumer and greater consumer choice – The elimination of trade barriers (along with increased competition and economies of scale) results in lower prices for consumers. Access to markets and economies of scale – A country that joins a trading bloc would have access to the markets of the whole bloc.

Answer 5

One problem that arises in a customs union is that member countries must coordinate their policies toward non-members. This gives rise to the possibility of disagreements, as they may not all agree on what are appropriate levels of tariff and other barriers on non-members. Loss of sovereignty-As integration becomes greater, countries will lose some degree of economic and political sovereignty. Undermine trade liberalization (free trade) – The establishment of many trading blocs can create trade conflicts between different blocs that may slow down the process of global trade liberalization (free trade).

Answer 6

Foreign demand for exports of goods and services – If there is an increase in foreigners’ demand for US goods, the demand for exports increases and the demand for dollars rises. Inward foreign direct investment (FDI) and portfolio investment – There are two types of investment: foreign direct investment (investment by multinational corporations in productive facilities) and portfolio investments (financial investments, such as purchase of stocks and bonds). Both types of investment have the same impact on exchange rates. Relative interest rates – Financial capital refers to funds that are used to make financial investments that receive a return based partly on the rate of interest. Speculation that a currency will appreciate – Currency speculation involves buying and selling currencies to make a profit from changes in exchange rates.

Answer 7

Inflation – If the value of the exchange rate is low, both demand-pull and cost-push inflationary pressures may rise. This is because a lower value currency, by making exports cheaper and imports more expensive, works to increase the quantity of exports and lower the quantity of imports, thus increasing net exports (X-M). Standard of living – If the value of the exchange rate is low, it causes imported goods to become more expensive in the domestic economy, therefore residents become worse off as all imported goods become more expensive. Unemployment Decreases as the economy grows.

Answer 8

Argentina's annual inflation rate ended 2023 at 211.4%, the highest since the early 1990s.

Answer 9

Trade protectionist policies could be used to correct a long-term current account deficit. Trade protectionist policies (ie, tariffs, quotas or subsidies) prevent the free entry of imports into a country by raising the price of foreign imports. The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods. However, trade protectionist policies have a number of negative effects, such as higher domestic prices of protected goods and lower domestic consumption. Also, protecting domestic industries reduces competition, which may encourage them to be inefficient. Finally, there also arises a danger that countries against which the protective barriers are imposed may retaliate with their own barriers. Depreciation (or devaluation) of currency could be used to correct a long-term current account deficit. A depreciation (or devaluation) of currency encourages exports (which become cheaper to foreigners) and discourages imports (which become more expensive to domestic buyers). The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods. However, this policy too may have negative effects on the domestic economy. Higher import prices due to the lower value of the currency often result in higher domestic inflation. If the imported goods include capital goods and other imported inputs, firms experience higher costs of production, which may be passed on to consumers in the form of higher prices. This is a type of cost-push inflation, and by shifting the SRAS curve to the left, may have recessionary effects.

Answer 10

Depreciation (or devaluation) of a currency can have negative effects on the domestic economy. Higher import prices due to the lower value of the currency often result in higher domestic inflation. If the imported goods include capital goods and other imported inputs, firms experience higher costs of production, which may be passed on to consumers in the form of higher prices. This is a type of cost-push inflation, and by shifting the SRAS curve to the left, may have recessionary effects. Trade protectionist policies have a number of negative effects, such as higher domestic prices of protected goods and lower domestic consumption. Also, protecting domestic industries reduces competition, which may encourage them to be inefficient. Finally, there also arises a danger that countries against which the protective barriers are imposed may retaliate with their own barriers.

Answer 11

Trade protectionist policies could be used to correct a long-term current account deficit. Trade protectionist policies (ie, tariffs, quotas or subsidies) prevent the free entry of imports into a country by raising the price of foreign imports. The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods. Depreciation (or devaluation) of currency could be used to correct a long-term current account deficit. A depreciation (or devaluation) of currency encourages exports (which become cheaper to foreigners) and discourages imports (which become more expensive to domestic buyers). The purpose of this policy is to switch domestic consumption away from foreign imports and towards domestically produced goods.

Answer 12

A current account deficit is when the current account adds up to be negative. Exchange Rates: A deficit can lead to currency depreciation due to decreased demand for domestic currency, impacting exports and imports. This can affect households, potentially leading to inflation and reduced competitiveness for firms reliant on imports. Interest Rates: Financing the deficit may require higher interest rates to attract foreign capital, potentially reducing aggregate demand, causing economic slowdown, and increasing unemployment. Foreign Ownership of Domestic Assets: Selling domestic assets to foreigners can finance the deficit but may raise concerns about economic sovereignty, especially if strategic assets are involved. Debt: Financing through borrowing increases foreign debt, requiring interest payments that divert funds from other sectors like infrastructure, health, or education, potentially hindering economic development. Lower Credit Rating: Accumulating foreign debt may lower credit ratings, making it harder to secure future loans and potentially leading to higher interest rates, exacerbating debt issues and possibly causing or deepening recessions. Economic Growth: A deficit can reduce economic growth as consumers shift to importing goods, leading to decreased domestic production, layoffs, reduced aggregate demand, and ultimately, a recession with increased unemployment and decreased GDP growth.

Answer 13

Contractionary monetary policy could be used to correct a long-term current account deficit. Contractionary monetary policy is where the government intervenes in the economy by raising interest rates. This slows down investment (I) and consumption (C), which reduces aggregate demand. The purpose of this policy is to reduce aggregate demand, resulting in lower levels of real GDP (national income), which means consumer incomes are falling and buying fewer domestic and imported goods. The combination of fewer imports and more exports may work to reduce the current account deficit. Contractionary fiscal policy could also be used to correct a long-term current account deficit. Contractionary fiscal policy is where the government intervenes in the economy by cutting government expenditure (G) or increasing taxes (C or I). This will lead to less aggregate demand in the economy because households are left with less disposable income and firms with less after-tax profits to invest. Similarly, the purpose of this policy is to reduce aggregate demand, resulting in lower levels of real GDP (national income), which means consumer incomes are falling and buying fewer domestic and imported goods. The combination of fewer imports and more exports may work to reduce the current account deficit.

Answer 14

too much contractionary policy will push aggregate demand too far and may create a recession. the higher costs of borrowing as a result of higher rates from contractionary monetary policy may create a recession in the domestic economy. Moreover, there is also a risk that higher interest rates (contractionary monetary policy) leads to currency appreciation, which may discourage exports and encourage imports, partly canceling out the beneficial effects of expenditure reducing policies on imports and exports.

Paper 3 Mock exam Flashcards

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