Question

a) With the aid of a consumption function, highlight the main determinants of consumption. (5 marks)

b) “International trade is beneficial to developing countries.” Do you agree? Discuss your arguments with the support of at least one international trade theory. (15 marks)

c) As a trade specialist, outline the policies which the Botswana government can use to promote international trade. (10 marks)

Answer 1

A) $C =\overline{C} + MPC* YD$ is the consumption function where,

C bar = Autonomous Consumption, that is, the consumption when the consumer's income is zero

MPC = marginal propensity to consume, it means the proportion of incremental income that the consumer spent on consumption, that is, MPC= 0.5 means that if consumers income increase by 1$, consumer will spent 0.5$ on consumption and will save the rest, and

YD = Disposable income, the income that consumer left after paying taxes and receiving transfers.

Therefore, the main determinants of consumption function are Consumer's income, taxes, transfers and interest rates(which affect the MPC value).

A higher taxes means lower disposable income and higher transfers means higher disposable income. And a higher disposable income will result in higher income.

And there's a negative relationship between interest rate and MPC. a higher interest rate means that a consumer can earn on his income and will save larger proportion of his income, which will result in lower value of MPC. A lower MPC means low consumption value.

B) Yes, International trade is beneficial to developing countries. For many developing countries, progression from low income to middle and upper middle income country rests heavily on successful trade in both regional and global markets. Successful trade provides for a developing nation in following ways :

1) A source of foreign currency, which further helps in improvement in balance of payments. A trade surplus builds a nation's reserve,

2) It's an important way of financing imports of essential capital machinery and new technology,

3) Increased employment opportunities in export and related industries which will result in higher per capita income

4) Increased competition will ensure lower prices which will result in higher real income of consumers

Conventional trade theory suggests that there is a standard process through which this takes place.

Exporting primary goods, Import Substitution and Export - focussed manufacturing production

C) There are many policies that a government can use to improve it's international trade. Some of them are as follows :

Simplifying Regulation = The government should simplify regulation related to exports; long procedures negatively affect especially new exporters. Actions in this category should also consider product standards and other technical requirements for exporting.

Increasing the availability of credit = The availability of short and long term credit is crucial to exporters. Since Small and Medium enterprises make up the large majority of firms in developing nations, improvement in this domain is necessary to favour export growth.

Improving cooperation among economic actors = Besides these, export growth could be favoured by improving cooperation among exporters and between the government and business actors.