ACJC H2 Prelim 2024 P2 EQ5 Solutions

5(a) Explainwhyagovernment shouldavoidalargeandpersistent balanceoftradesurplusanddeficit. [10] QuestionAnalysis CommandWord “Explain”● Start:BOTsurplus&deficit● End: Negativeconsequences, andhenceaconcernforthegovernment● Noevaluationneeded Concept ● UnpackBOTsurplusanddeficit● HarmsofBOTsurplusanddeficit Context General Introduction:Thebalanceoftrade(BOT)isthedifferencebetweenacountry'sexportrevenue(X)andimportexpenditure(M).MostcountriesaimforeitherBOTsmallsurplus(X>M)oraBOTequilibrium,wheretheX=M. Requirement 1: Governmentstendtoavoidalargeandpersistent BOTdeficit becauseit couldlower thestandardof living(SOL) for futuregenerations. Notetostudents: Youareencouragedtoprovideatleastmorethan1negativeconsequencesduetoalargeandpersistentBOTdeficit. Alargeandpersistent BOTdeficit impliesthat acountry'sX-revenuekeepsfallingandM-expenditurekeepsrising. Thissuggeststhat theADislikelytofall. If the country isproducing far belowthe full capacity,thismayleadtonegativeeconomicgrowthduetothereversemultiplierprocess.Inthiscase,thefallinADresultsinan unplanned rise ininventory stocks,signalling firmsto decrease outputandhence,RNOfalls,resultinginnegativeeconomicgrowth.Furthermore,thisalsoreducesthederiveddemandfor factorsof production(e.g.labour),causingfirmstohirefewer andfiremoreworkers, increasingdemand-deficient unemployment. Thefallinderiveddemandforfactorpaymentsalso reduces factor payments,resultinginafallinhouseholdincome, reducing purchasing power,andinducingafallinCbytheamount equal toMarginal PropensitytoConsume(MPC)xthemagnitudeof thefall inincome.ThiscausesADandRNOtofallagain.Thisprocessrepeatsitselfuntil RNOfallsbyamultipliedamountequalto(1/mpwxoriginalfallinAD). ABOTdeficitimpliesacountry'sX<M.Ifacountrydoesnothavesufficientforeignreserves,itmayhavetoborrowfromtradingpartnerstofinancetheBOTdeficittomanagethefluctuationsinitsexchangerate,assumingthecountryisinafixedormanagedfloatexchangerateregime.Alargeandpersistentdeficitmakesthismorelikelyand

increasesthesizeof theforeigndebt.Thisincreasestheprincipalsumandinterestpaymentsthathavetoberepaidinfuture.Agovernmentmaybeforcedtoraisetaxes(e.g.personalincometax)forfuturegenerationstoraiseenoughrevenuetopayitsdebts,reducinghouseholddisposableincomeandthepurchasingpowerofthefuturegeneration.Thiscouldreducethequantity, qualityandvarietyof goodsandservicesthat canbeenjoyedinfuture,reducingtheirtangibleaspectofwellbeing,andhencematerialSOLofthefuturegeneration. Additionally,ifthisreduceshouseholdaccesstohealthcareornutrition,itcouldalsoreducethe quality of health, leadingtomoreillnessesandalowerlifeexpectancy.Ifthelowerpurchasingpowerreducesaccesstoeducation,itcoulddetersomestudentsfromfurtherstudies,loweringtheaverageyearsofformaleducation.Coupledwithlowerlifeexpectancy,this could lower the HDI value, ceteris paribus, which suggests a lower non-materialstandardoflivingofthefuturegeneration. Notetostudents: (i) ABOTdeficit couldleadtoacurrencydepreciation.LinktotheeffectsofadepreciationsuchasincreaseCO