Time: 2000 Hours Local Time
Location: Unknown
Question: A country has a deficit on the current account of its balance of payments. Discuss whether this is necessarily harmful to the country? May/Jun 2005, I try my best to answer this question. Warning: Please do not believe what i have written here! Its up to you!
One of the component for the balance of payments is Current Account. Under Current account its include Visible balance, Invisible Balance, Services and Transfers. A deficit on the current account means there is a huge amount of outflow of money than inflow. Does this may lead to a harmful to a country? Well, its depends!
First, we look at Visible balance, I prefer to call it BoT ( Balance of trade ) I get used to call it at school. What do we understand about BoT? Export Revenue - Import Spending = BoT or Price of Export x Quantity of Export Minus Proce of Import x Quantity of Import, It just same. What can bring the BoP to deficit in relation to BoT? I have many possibilities here:
Case 1
The question asked, is it harmful to a country? In this case, I'd like to say Yes! Why? Automatically we know that BoT has worsen due to Import Spending is higher than Export Revenue. Assume the Price of Export goes up, and the price of import has fallen, this can affect the demand of the good, so PED (Price Elasticity Demand) involved. If the Px goes Up, and the Pm fallen, and the PED for both X and M ( X- Export, M - Import ) is elastic, I'm sure the BoT will be worsen!
Case 2
Same situation from case 1 but what if both PED for X and M is inelastic, Does this can bring improvemnet to BoT? Yes! Price goes Up but demand for X decrease less than proportionate, so X Revenue Increases, same goes to M, Pm fallen, demand increase less than proportionate, as a result import spending has fallen, when X revenue is greater than import spending, we call that the BoT has improved!
I think my answer is not fully completed, but I have another work to do, hope if I have a free time, I'll continue later. Again, if there's anything wrong with my answer, please raise it up!
Monday, October 19, 2009
Thursday, October 15, 2009
Devaluation is a dirty word. It stinks of failure!
Time: 0040Z
Local Time: 0840
Status: Studying
Location: School (U6-2)
Today's topic also about ER. Its all about Revaluation and mostly Devaluation, and this only apply to Fixed Exchange Rate System. Differ from Floating Exchange Rate where the rate is determined by the market forces of demand and supply either depreciate or appreciate with no government intervention unlike FER, with government intervention to the market, the exchange rate is being control or setting up by policymakers to revalue or devalue it currency at particular point. Say there's one authority, and they set a policy to their currency, and they want their currency to devalue to 1 Pound equal to 1.5 Dollar, not beyond this limit. Initially 1 pound is equivalent to 2 dollar, and suddenly the demand for pound is increase, Increase DD for pound lead to revalue, in order to devalue, the authority need to sells their currency to achieve back 1 pound = 1.5 Dollar, therefore Supply of pound increase, and Supply curve is shifted. If the authority can't support or hold the policy ( 1 Pound = 1.5 Dollar ) , the policy failed.
Why government intervene? why they want to revalue their currency?
With government intervention, the currency is much lower as result of devaluation. Price of export more likely to be cheap and more competitive and price of import is more to become expensive. In order to improve BoT, Both price elasticity of demand of export and import must be elastic. Unemployment also has fallen due to increase in Aggregate Demand (one of the component of AD is [x-m]) as Export Revenue is higher than import spending. There's one theory called Marshall-Lerner Condition, both are economist. It says that if currency devalue, it could give a big positive impact to trade balance aka BoT if the PED of Export and Import is > 1.
This can be defined as: PEDx + PEDm > 1, the higher the total PED, the more effective devaluation is. And to satisfy this, it might be a long run to let PEDx and PEDm more elastic (the more longer the time period, the more elastic the demand is). *need critiction*. In a short run, it will affect BoT to deficit (worsen). My statment above can be seen or prove through J-Curve More resources about devalution please refer to here.
Thanks to Sir V! Credit to him..
Taken From my other blog!
Local Time: 0840
Status: Studying
Location: School (U6-2)
Today's topic also about ER. Its all about Revaluation and mostly Devaluation, and this only apply to Fixed Exchange Rate System. Differ from Floating Exchange Rate where the rate is determined by the market forces of demand and supply either depreciate or appreciate with no government intervention unlike FER, with government intervention to the market, the exchange rate is being control or setting up by policymakers to revalue or devalue it currency at particular point. Say there's one authority, and they set a policy to their currency, and they want their currency to devalue to 1 Pound equal to 1.5 Dollar, not beyond this limit. Initially 1 pound is equivalent to 2 dollar, and suddenly the demand for pound is increase, Increase DD for pound lead to revalue, in order to devalue, the authority need to sells their currency to achieve back 1 pound = 1.5 Dollar, therefore Supply of pound increase, and Supply curve is shifted. If the authority can't support or hold the policy ( 1 Pound = 1.5 Dollar ) , the policy failed.
Why government intervene? why they want to revalue their currency?
With government intervention, the currency is much lower as result of devaluation. Price of export more likely to be cheap and more competitive and price of import is more to become expensive. In order to improve BoT, Both price elasticity of demand of export and import must be elastic. Unemployment also has fallen due to increase in Aggregate Demand (one of the component of AD is [x-m]) as Export Revenue is higher than import spending. There's one theory called Marshall-Lerner Condition, both are economist. It says that if currency devalue, it could give a big positive impact to trade balance aka BoT if the PED of Export and Import is > 1.
This can be defined as: PEDx + PEDm > 1, the higher the total PED, the more effective devaluation is. And to satisfy this, it might be a long run to let PEDx and PEDm more elastic (the more longer the time period, the more elastic the demand is). *need critiction*. In a short run, it will affect BoT to deficit (worsen). My statment above can be seen or prove through J-Curve More resources about devalution please refer to here.
Thanks to Sir V! Credit to him..
Taken From my other blog!
Subscribe to:
Posts (Atom)
