Question

Question 24 This question has two parts: A and B A. Many countries design and implement a trade policy when dealing with import of goods and services from foreign markets. Explain why some countries would want to restrict imports and suggest how these countries implement restrictions of imports (6 marks) B. Country X is a small island open economy. National income details are calculated as follows: Consumption expenditure (0)5300. Government expenditure (G) $250. Investment spending 00 $350. exports $15000 and imports (M) $50. Calculate the GDP. National Savings and Capital inflows. (3 x 3 marks - 9 marks)

Answer 1

Question 24

A. Import and Import Restrictions:

Government of a country undertakes trade restriction in order to protect domestic consumers and domestic employees from foreign competition. Under a protectionist policy, the importation of goods and services produced in the foreign country is restricted. Some of the policy tools to restrict imports are mentioned below:

o Tariff: In case of a tariff policy, a per unit tax is imposed on the import of goods. This leads to an increase in the price of imported goods and lowers the domestic demand for these goods. This way domestic producers are made better off by producing and selling domestic goods at higher prices and they are able to earn larger profits. The tariff could be a Protective Tariff imposed with the intention to specifically increase the price of foreign goods and protect domestic industries or it could be a Revenue Tariff imposed with an intention to raises revenue for the government spending. Generally a tariff is able to solve both the above motives.

o Import Quota : Under a quota policy, the government imposes a limit on the quantity of foreign goods than can be imported. This way, the quantity demand of imported goods exceeds the quantity supplied in the domestic market. In response to this shortage, the domestic producers are able to raise their prices, expand production and enjoy a larger share of producer surplus.

o Subsidies: The policy of granting subsidies works in reverse of a tariff policy. Here rather than taxing the quantity of imports, the government provides financial assistance to domestic producers in the form of subsidy in order to encourage exports. The domestic producers can easily incur their production costs using the subsidy amount and thus charge a lower price on their goods in comparison to foreign imported goods. The main goal of such a policy is to increase the demand for domestically produced goods and discourage imports.

o Embargoes: Another extreme form of import restriction which a government might use is called as embargos or import bans. Under this, the import of a particular good or trade with a certain country is strictly prohibited. For example, in-case of a pandemic like COVID-19 these days, many countries have imposed temporary bans on international trade in order to spread the virus and protect national health.

o Import Regulations or Standards: At times the government of a country may implement certain rules and regulation for the goods to be imported. These could be in form of certain health and safety standards. Such standards could be higher for the imported goods as compared for the domestically produced goods. These standards are required to be maintained in order to ensure that the imported goods are safe for consumption use. The standards are generally required for the import of food, medicines, cosmetics, etc.

o Sanctions: Restrictions and bans on imports could also be due to political reasons. An unethical behavior by another country in the form of human rights violation or an act of aggression may induce the government to either temporarily or permanently restrict imports from that country. Such restrictions are called as Sanction measures.

B. We are given the below details for country X which is a small open economy :

C = $300 , G = $250 , I = $350, Exports = $150, Imports = $50

o At equilibrium, the aggregate expenditure in an economy is equal to its GDP. Thus sing expenditure approach:

AE = GDP = C + I + G + (X – M)      

GDP = 300 + 350 + 250 + 150 – 50

Y = GDP = $1000

o National Saving of any country is the sum of country’s private and public savings which can be calculated as :

National Savings = Y – C – G = 1000 -300 – 250 = $450

o A country’s net capital inflows is the difference between the country’s national savings and investment, which could also been seen as a negative net exports.

Net Exports = X – M = 150 – 50 =$100

National Savings + Net Capital Inflows = Investment

National Savings – Investment = (-) Net Capital Inflows

450 - 350 = (-) Net Capital Inflows

Net Capital Inflows = (-) $100 = (-) NX

Question 19

Given the above situation, the actual GDP = $1000 and the potential GDP = $1200. When the actual GDP falls short of the potential GDP, the economy experiences a negative output gap known as Recessionary Gap. In this situation, Aggregate Demand falls short of the Aggregate Supply and the economy is expected to move towards a Recession. Due to lack of demand of goods and services, prices experiences a downwards pressure to which the producers respond by cutting down production in order prevent further losses. Lower production rates reduce the demand of labor and result in an increased unemployment in the economy.

Reduction of Required Reserve ratio (from 15% to 10%) is an Expansionary Monetary policy tool which the central bank uses to bring the economy out of recession. With a fall in required reserve ratio, commercial banks are now required to keep lesser proportion of deposits as reserve and are able to make greater proportions of loans in the loanable fund market. Greater the amount of loans these banks can make, greater is the new money generated in the economy. As money supply increases, the interest rate falls. This induces the households and firm to increase their consumption and investment expenditure as borrowing becomes less expensive. With an increased aggregate spending, aggregate demand rises and the economy moves back to the long run equilibrium – where output stabilizes back to full potential level. Unemployment falls and the price level increases.