Question

Subject 2: National Accounts & Balance of Payments (30%) A. The government of Acadia, instead of giving its unemployed persons 100 No Values (NV) monthly as an unemployment benefit, has decided to hire them with a monthly salary of 100 No Values. The country's GDP will grow or fall? [Mark: 0.5] OURAMME IN BUSINESS ADMINISTRATION B. Suppose now that Acadia experiences a current account deficit. Which are the best policy tools to combat this deficit? Discuss the pros and cons. [Mark: 1.5] C. Finally, suppose that Acadia enters into a recession: Interest rates and investments are zero, while the country cannot expand its budget because it cannot borrow due to high public debt. A proposal by Economic Advisor A, to get the country out of recession, is to issue new money. Economic Advisor B opposes this because he/she believes that such a policy will create side-effects, given the country's high external borrowing. Explain the arguments for and against A's proposal and explain why B can also be right. [Mark: 1.0]

Answer 1

(A.) The government of Acadia, instead of giving its unemployment persons 100 No Values (NV) monthly as an unemployment benefits, has decided to hire them with a monthly salary of 100 No Values. The country's GDP will grow.

Explanation

The country's GDP will grow because government of Acadia hire unemployment persons instead of giving unemployment benefits. If government of Acadia give its unemployment persons 100 No Values (NV) monthly as an unemployment benefits then only in that case country's GDP will fall. But government of Acadia hire unemployment persons, it results in increased economic activities and thereby, the country's GDP will grow.

(B.) The following policy tools can be used to combat this current account deficit:

Expenditure switching policy

Expenditure switching policy, In which Government of Acadia may adopt all such polices which lead to reduction of consumption / imports and  encourage consumption / production of domestically produced goods. Which ultimately helpful for Government of Acadia to overcome its current account deficit.

Devaluation

Devaluation refers to lowering the value of domestic currency in terms of foreign currency. Devaluation of currency make import expensive. Which means to more money required to import same quantity of product. Devaluation Promote Exports and discourse imports. Therefore, Devaluation of currency is helpful for Government of Acadia to overcome its current account deficit.

Expenditure reducing policy

Expenditure reducing policy, In which Government of Acadia may increase income tax and lower its government expenditure to overcome its current account deficit. The increase in income tax and lower its government expenditure lead to lower aggregate demand in the economy. It lead to lower demand for imports. Therefore, Expenditure reducing policy is helpful for Government of Acadia to overcome its current account deficit.

Pros

1. Stimulate more economic activity.

2. Domestic economy is capable to adjust with domestic economy.

3. There is less inflation in the economy.

4. The most important it encourage Exports and discourse Imports.

Cons

1. Not always helpful to to promote or stimulate faster economic growth

2. Such policies need long to be seen in reality.

3. It may lead to higher level of inflation in the economy.

4. It may works as barrier to imports.

(C.) Proposal by Economic Advisor A, to get the country out of recession, is to issue new money can used as policy measure for recession in Acadia. During recession the first purpose of any policy is to stimulate aggregate demand in the economy. The Proposal by Economic Advisor A, lead to more supply of money in the economy. Which means more money for consumption in the hand of public, which stimulate aggregate demand in the economy.

As far as Proposal by Economic Advisor B is concerned, the point rise by Economic Advisor B is also right as such a policy will create side-effects, given the country's high external borrowing. The basic point is that, given the country's high external borrowing, increase in money supply may lead to very high level of inflation in the economy. Which will create side-effects. Therefore, Economic Advisor B can also be right .