Correcting Balance of Payments Deficit

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Questions and Answers

What is one way to stimulate exports in a country with a deficit in balance of payments?

By reducing government expenditure

By imposing higher duties on imports

By granting bounties to industrialists and exporters (correct)

By granting subsidies to importers

Which method is used to restrict imports in a country with a deficit in balance of payments?

Quota system (correct)

Reducing disposable income

Devaluation of currency

Increased government expenditure

What is the purpose of devaluation in correcting an adverse balance of payments?

To increase government revenue

To increase the price of exports

To make imports cheaper

To cheapen exports and make imports dearer (correct)

What is the result of deflation in a country with a deficit in balance of payments?

Decrease in prices Signup and view all the answers

What is a risk of deflation in correcting an adverse balance of payments?

Labor opposition to wage reduction Signup and view all the answers

What is the objective of restricting imports in a country with a deficit in balance of payments?

To reduce the deficit in balance of payments Signup and view all the answers

What is an exchange rate adjustment referred to as?

Devaluation Signup and view all the answers

Which of the following is NOT a method to correct an adverse balance of payments?

Increased government borrowing Signup and view all the answers

What can lead to disequilibrium in the balance of payments?

Decrease in production at home Signup and view all the answers

What happens when imports remain unaffected or increase, and exports do not equalize?

Deficit in balance of payments Signup and view all the answers

Why is it necessary to correct a deficit balance in perpetuity?

To avoid economic instability Signup and view all the answers

What was the mechanism of adjustment under the gold standard?

Changes in quantity of money and relative price levels Signup and view all the answers

What can stimulate exports and discourage imports?

Depreciation in the currency Signup and view all the answers

What can result from an inflow or outflow of gold?

Expansion or contraction of domestic money supply Signup and view all the answers

What can lead to a rise or fall in domestic costs and prices?

Expansion or contraction of domestic money supply Signup and view all the answers

What can correct a deficit balance in perpetuity?

Devaluation and exchange control Signup and view all the answers

What does the permanent income hypothesis suggest that consumers will attempt to do?

Smooth consumption over their lifetime Signup and view all the answers

Which theory suggests that spending is dependent on current income, future expected income, and wealth?

Life cycle hypothesis Signup and view all the answers

What is the acceleration principle concerned with?

The connection between output and capital investment Signup and view all the answers

What is the result of the acceleration principle on the economy?

It exaggerates booms and recessions Signup and view all the answers

Why do companies invest in more factories and capital investments during a boom?

To optimize their profits Signup and view all the answers

What happens to investment during a recession according to the acceleration principle?

It decreases Signup and view all the answers

What is the result of reduced investment during a recession?

It can increase the length of the recession Signup and view all the answers

Study Notes

Methods to Correct a Deficit in Balance of Payments

To correct a deficit, a country must stimulate exports or discourage imports, or do both.
Exports can be encouraged by:
- Lowering costs in the country
- Granting bounties or concessions to industrialists and exporters
Imports can be restricted by:
- Adopting a quota system
- Imposing duties
- Reducing people's disposable income or government expenditure
- Total prohibitions

Deflation

Deflation is used to correct an unfavorable balance of payments
The currency authority reduces the quantity of money in circulation to lower prices
This makes the country a good market to buy from and a bad market to sell in, encouraging exports and reducing imports

Devaluation

Devaluation is a remedy used in extreme crises to correct an adverse balance of payments
It involves lowering the exchange rate to cheapen exports and make imports dearer
This raises exports and lowers imports

Other Theories of Consumption

Permanent Income Hypothesis

Consumers' consumption is determined by current and future expected income
They attempt to smooth consumption over their lifetime

Life Cycle Hypothesis

Consumers' spending is dependent on current income, future expected income, and wealth
They attempt to smooth consumption over their lifecycle

Acceleration Principle

An increase in demand for consumer goods leads to a greater increase in demand for machines and investment necessary to make those goods
This principle exaggerates booms and recessions in the economy
Companies invest in more factories and capital investments during booms, and reduce investment during recessions, leading to job losses and prolonging the recession

Disequilibrium in Balance of Payments

Disequilibrium arises when exports fall short of imports due to various reasons such as decreased production, stiffer competition, or appreciation in the currency
Deficit in balance of invisible items can also lead to disequilibrium in the balance of payments

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Description

Learn about the methods a country can adopt to correct a deficit in its balance of payments, including rectifying the balance of trade and stabilizing exchange rates.