2026 ACJC H2 Econs Paper 2 Q6 Prelim ANS

2026 H2 Economics Preliminary Exam Question 6 (a) Explain one internal and one external factor that will cause a country to have a persistent trade deficit. [10] (b) Discuss whether the US government should only use tariffs to correct her persistent trade deficit regardless of the unintended consequences of such a policy [15] Suggested Approach Question Requirements: ● Requirement 1: Explain one internal factor that causes a persistent trade deficit. ● Requirement 2: Explain one external factor that causes a persistent trade deficit. Suggested Answer Introduction A balance of trade (BOT) deficit occurs when a country's import expenditure (M) exceeds its export revenue (X). A persistent trade deficit refers to one that is sustained over a prolonged period of time, rather than a temporary or cyclical imbalance. Such a deficit can arise from both internal factors, those originating from within the domestic economy and external factors, those driven by conditions in the rest of the world. Both internal or external factors affect either the country's export revenue, its import expenditure, or both. Requirement 1: Internal Factor — Loss of Comparative Advantage Due to Lack of Technology Upgrading ● failure of domestic firms to upgrade their technology, which over time leads to a loss of comparative advantage in the goods and services the country previously exported competitively. ● A country is said to have a comparative advantage in the production of a good when it can produce that good at a lower opportunity cost than its trading partners. In practice, a country's comparative advantage in a particular industry is often underpinned by its level of technological development — advanced production technology allows firms to produce more output per unit of input, decreasing its opportunity cost of production ● Ability to increase productivity through technology lowers the unit cost of production and enables the country to offer its goods at internationally competitive prices. ● When domestic firms fail to invest in upgrading their technology over time, their productivity growth stagnates. Meanwhile, trading partners that continue to invest in technological advancement will experience rising productivity, falling unit costs of production, and an improvement in their own comparative advantage in the same industries ● Over time, the home country's goods become relatively more expensive to produce compared to those of its technologically advancing rivals. The home country therefore gradually loses its comparative advantage in these industries. ● loss of comparative advantage has a direct and sustained impact on the BOT. ● On the export side, the home country's goods become less price competitive in international markets as its unit costs of production rise relative to those of its rivals. ● Foreign buyers will substitute away from the home country's exports towards cheaper alternatives produced by more technologically advanced competitors. This causes export revenue (X) to fall persistently

● On import side, domestic consumers and firms may also find it more cost-effective to purchase technologically superior foreign goods rather than domestically produced alternatives, causing import expenditure (M) to rise. ● loss of comparative advantage due to technological stagnation is not easily or quickly reversed. Rebuilding technological capability requires sustained investment in research and development, worker retraining, government financial support and infrastructural development and all these take considerable time to translate into productivity gains. ● inability to keep up with technological advancement will result in the country's export revenue falling and its import expenditure rising, sustaining the trade deficit over the long run. ● For example, if a country's manufacturing sector fails to adopt automation and advanced production techniques while competitors in other countries do so, the home country's manufactured exports will become progressively less competitive in global markets. Export orders will decline, and domestic firms may increasingly rely on importing technologically superior intermediate goods and capital equipment, further widening the trade deficit. Requirement 2: An external factor that causes a persistent trade deficit is protectionism or unfair trade practices by trading partners. ● government policies and unfair trade practices that restrict international trade ● e.g import tariffs, quotas, or subsidies to domestic industries in the trading partner country and undervaluation of trading partners’ currency ● protectionist policy ● when a trading partner imposes tariffs on the home country's exports, the price of those exports rises artificially in the foreign market. This makes the home country's goods less price competitive relative to domestically produced goods or goods from other countries ● foreign consumers reduce their quantity demanded for the home country's exports, leading to a fall in export revenue for the home country ● unfair trade practices ● when the trading partner subsidises its own domestic industries, those firms can produce at a lower cost and undercut the home country's exports in both the foreign market and potentially in the home country's own domestic market, This further erodes the home country's export competitiveness, causing export revenue to fall persistently and potentially raising import expenditures too ● since the home country's export revenue (X) falls while import expenditure (M) may remain unchanged or rise, the net export revenue (X – M) becomes increasingly negative, resulting in a persistent trade deficit ● especially damaging if the affected trading partner is a major export destination, as the loss of export revenue cannot easily be offset by redirecting exports to other markets in the short run. ● Example: Following China's integration into the global economy, China had for decades pursued an undervaluation of the Renminbi (RMB) against the US dollar and provided heavy subsidies to its manufacturing industries. These policies lowered the relative prices of Chinese