2012 JC2 H1 Economics

TP Chap 12 Section 3A Question 3 & 4

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 3

3. USAs trade deficit with China alone was $201.6 billion, an all-time high for a trade deficit with any country.
Adapted from San Francisco Chronicle, Feb 2006

Explain some possible causes of a balance of trade deficit and consider if USA should be concerned over its trade deficit with China. [12]

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 3

3. Explain some possible causes of a balance of trade deficit and consider if USA should be concerned over its trade deficit with China. [12]

Sample 1: One possible cause of balance of trade deficit is an increase in income level of consumers. As the consumers income increase, they are more able to buy things. This will cause imports to increase.

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 3

3. Explain some possible causes of a balance of trade deficit and consider if USA should be concerned over its trade deficit with China. [12]

Sample 2: One possible cause of balance of trade deficit is an increase in income level of domestic consumers. Due to the rise in income level, consumers purchasing power is increased. The greater ability of consumers to purchase imports will lead to an increase in import expenditure , causing a BOT deficit. On the other hand, a fall in income of a countrys trading partner will reduce their ability to purchase imports, reducing the export revenue of the host country. This will similarly lead to a BOT deficit.

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 3

3. Explain some possible causes of a balance of trade deficit and consider if USA should be concerned over its trade deficit with China. [12] Sample 3: One possible cause of balance of trade deficit in US is the undervaluation of Chinese yuan. Undervaluation refers to the official exchange rate of the yuan being fixed below the market expected exchange rate. When yuan is undervalued, the Chinese products in US will be relatively cheaper than domestic goods. On the other hand, American products in China will be relatively more expensive than the local Chinese goods. As such, the increase in demand for Chinese imports will cause an increase in USs import expenditure, the fall in demand for USs exports will cause a fall in her export revenue, hence causing a BOT deficit for US.

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 3

One possible cause of balance of trade deficit in US is the undervaluation of Chinese yuan. Undervaluation refers to the official exchange rate of the yuan being fixed below the market expected exchange rate. When yuan is undervalued, the Chinese products in US will be relatively cheaper than domestic goods. On the other hand, American products in China will be relatively more expensive than the local Chinese goods. As such, the increase in demand for Chinese imports will cause an increase in USs import expenditure, the fall in demand for USs exports will cause a fall in her export revenue, hence causing a BOT deficit for US.

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2012 JC2 H1 Economics TP Chap 12 Section 3A Question 4

Outline the economic policies that might be used to reduce a large and persistent deficit on the current account of the balance of payments. [10] Introduction:

Balance of payments (BOP) record the international transactions of a country with the rest of the world, usually within a year. The BOP consists of mainly the current account and the capital account. Current account records the transactions of exports and imports of goods and services, unilateral transfers and income balances, while capital account measures the short term and long term capital flow between the country and the rest of the world. A large persistent current account deficit can be solved by implementing expenditure reducing and expenditure switching measures.

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 4

Outline the economic policies that might be used to reduce a large and persistent deficit on the current account of the balance of payments. [10] One of the expenditure switching measures is the use of tariff to reduce demand for imports and increase demand for domestic goods. Tariff is an indirect tax aimed at raising the prices of import. It can be in the form of specific or ad valorem tax In this context, US can impose tariff on the Chinese goods, such as textiles and steel. This will raise the price of Chinese textiles and steel, hence enticing the Americans to purchase local textiles and steel.

2012 JC2 H1 Economics TP Chap 12 Section 3A Question 4 Outline the economic policies that might be used to reduce a large and persistent deficit on the current account of the balance of payments. [10]

Reference fig 1: World SS is perfectly elastic P Assume US, price taker Sdom At Pw , domestic SS (Q1), quantity demanded (Q4), amount of import (Q1Q4) After tariff is imposed, increase in import price of Chinese textiles to Pw+T. US SS increase to Q2 SW + T PW + T (greater incentive due to increase PW SW in price), quantity demanded falls D to Q3 (Law of demand), amount of Q Chinese imports reduced to Q2Q3 Q1 Q 2 Q 3 Q 4 With a fall in demand for imports, USs import expenditure Figure 1: Imposition of Tariff will fall, hence reducing the current account deficit. on Chinese goods by US