H2 Prelims Paper 2 Q6_Suggested Answers

Suggested Response for Essay Question 6 6. To ensure that international trade remains smooth, open and reliable, one must resist the temptation to turn inwards, protectionism is not viable, especially for small states. (a) Explain how a country’s balance of trade may worsen over time. [10] (b) Discuss the view that the pursuit of a healthy trade balance leaves no room for the use of protectionism. [15] (a) Explain how a country’s balance of trade may worsen over time. [10] Command word Explain – use economic reasoning Start point: factors affecting X and M End point: worsen BOT Concepts Macroeconomic concepts Context Open context Introduction: - Defining balance of trade: X-revenue minus M-spending on all goods and services (visible and invisible trade balances) - Worsen BOT: falling X-revenue and rising M-spending - Causes of the worsening can be internal or externally driven. Students are expected to give at least 2 factors, of which at least one factor must link to both X-revenue reduction and M-spending increasing. The factors can include either of the following: 1) Poorer foreign economic growth or national income The changes in relative economic growth rates across countries may lead to changes in demand for the country’s exports or its demand for imports. For example, a fall in national income of a trading partner’s economy, relative to domestic would lower the foreign residents’ purchasing power, hence reducing their demand for imports. This could reduce the X-revenue of the domestic country. The fall will be more significant if the trading volume is larger and the country is a close trading partner. Therefore, with the fall in X-revenue relative to the import-spending, this may worsen a country’s BOT. 2) Exchange rate Appreciation of the country’s exchange rate will make the country’s exports become more expensive in its trading partner’s currency. At the same time, its imports are relatively cheaper in its own domestic currency. If demand for both export and import are price elastic, the higher price of the country’s exports (in foreign currency) will lower the country’s export revenue while its cheaper imports (in its domestic currency) will increase its import expenditure, leading to worsening of BOT.

3) Relative inflation rates If domestic costs of a country rise faster than costs abroad, its exports will be relatively more expensive than before and imports relatively cheaper. Assuming that demand for exports and imports are both price elastic, the increase in domestic costs will lead to a more than proportionate fall in the quantity demanded for exports, hence, reducing X -revenue. At the same time, its domestic residents may turn towards cheaper imports, leading to higher demand for imports, increasing M-spending. The fall in X and rise in M will lead to a worsening of the BOT. 4) Loss of comparative advantage due to lack of technological progressi