2022 JC2 H2 Prelim Essay Q6 (Suggested Answers).docx

6 (a) Explainoneinternalcauseandoneexternalcauseofabalanceoftradedeficit of a country. [10] (b) Discusswhetherprotectionismisthemostappropriatepolicytoimprovebalance of trade.[15] Suggested answer for (a) Introduction:Abalanceoftradedeficitcouldbearesultofafallintheexportrevenueofdomesticallyproducedgoodsand/oranincreaseinimportexpenditureonforeigngoods.Thiscouldoccur because of internal and/or external reasons. Explain an internal cause of BOT deficit: Higherdomesticinflationrelativeto the rest of the worldwill reduceexportcompetitiveness of a country and can cause a balance of trade deficit. Forexample,Indiahasbeenexperiencingrisingratesof inflationsincethestartof2022.Assumingpricesofothercountries’goodsandservicesriseataslowerratethanIndia,a higherincreasein domesticpricesin Indiarelativeto theforeignpriceswillcausedomestichouseholdsin Indiato increasedemandfor importedgoodsandservicesinsteadofdomesticallyproducedones,therebycausingimportexpendituretoincrease.At thesametime,moreexpensiveexportswillcauseforeignersto lowerquantitydemandedfortheexports.SincethedemandforIndia’sexportsislikelytobepriceelasticduetoavailabilityofsubstitutesfromothercountries,theincreaseinpricewillleadtoamorethanproportionatefallinquantitydemanded,causingexportrevenuetofall,ceterisparibus.ThefallingexportrevenueandrisingimportexpenditureworsenIndia’s trade balance and cause its balance of trade deficit to widen in 2022. Explain an external cause of BOT deficit: Withglobalisationandfreertradeflows,competitionfromemergingeconomiesmayleadtothelossofcomparativeadvantageofthemoredevelopedcountrieswhichcancause a balance of trade deficit. Ifthecountry’sdomesticallyproducedgoodsareseentobeofarelativelylowerqualityorrelativelyhigherpricedcomparedto foreigngoods,localconsumerswillswitchtobuyingtherelativelybetterqualityofcheaperimportedgoods.Thiswillresultinariseindemandforimportsandimportexpenditure.Ontheotherhand,foreignerswillalsobuy

lessofthedomesticallyproducedgoodsresultinginafallindemandforthecountry’sexportsandexportrevenue.Thefallinexportrevenueandriseinimportexpenditurewillleadtoa worseningofa country’s tradebalance.Forexample,theabundanceoflabour, landandotherrawmaterialsinChinahasresultedinaloweropportunitycostintheproductionof low-endmanufacturedgoodsthanthedevelopedcountriesliketheUS.ThiswouldmeanthattheChineselow-endmanufacturedgoodsaremorepricecompetitivethantheUSgoods.USwillexperienceafallinexportdemandandariseinimportdemand.AlossincomparativeadvantagewillthusleadtofallingexportrevenueandrisingimportexpenditurewhichworsenUS’s tradebalanceandresultedin abalance of trade deficit. Conclusion:Thus, both internal and external causes may cause a balance of trade deficit. L3 A well-developedanalyticalexplanationof bothinternalandexternalcausesof balanceof tradedeficit.Answershowsexcellent application with real world examples. 8-10 L2 Anundevelopedexplanationof thecausesof balanceof trade