Question

A. Countries often impose trade barriers against other countries. Explain how trade barriers affect both the domestic economy of the country imposing them and the global economy as a whole.

B. Describe how a contractionary monetary policy impacts a nation's international trade. Be sure to discuss the value of that nation's currency, the price of goods produced in that nation, and its trade balance.

C. Describe the effect of expansionary economic policies on a nation's trade deficit. Be sure to consider both monetary and fiscal policy.

D. According to the twin deficits effect, an increase in the government budget deficit will also increase that nation's trade deficit. Explain why this effect is expected to occur.

Answer 1

Ans.

a) Imposing trade barriers increases the prices of imports relative to the price of domestic goods which benefits domestic producers but hurts global production units. This increase in price of imports relative to the price of domestic goods increases market inefficiency because as now prices are high, so, people have to pay higher price for the good and because increased price is not market determined, so, it causes deadweight loss. Hence, trade barriers hurt foreign producers and domestic consumers.

b) A contractionary monetary policy leads to decrease in money supply which at given money demand increases the inerest rate in the market. This attracts the foreign investors increasing net capital inflow and demand for domestic currency increases leading to its appreciation. This leads to increase in price of exports but decrease in price of imports leading to decrease in demand for exports and increase in demand for imports. This worsens the trade balance.

c) An expansionary fiscal policy increases aggregate demand in the market leading to increase in money demand which at given money supply increases market interest rate. This attracts the foreign investors increasing net capital inflow and demand for domestic currency increases leading to its appreciation. This leads to increase in price of exports but decrease in price of imports leading to decrease in demand for exports and increase in demand for imports. This worsens the trade balance.

An expansionary monetary policy leads to increase in money supply which at given money demand decreases the market interest rate. This makes investment in domestic assets less attractive for investors increasing net capital outflow and decrease in demand for domestic currency. This depreciates the domestic currency leading to increase in prices of imports leading to decrease in their demand and decrease in prices of exports increasing their demand. This improves the trade balance of the country.

d) Increase in government expenditure leads to government deficit which increases aggregate demand in the market leading to increase in money demand which at given money supply increases market interest rate. This attracts the foreign investors increasing net capital inflow and demand for domestic currency increases leading to its appreciation. This leads to increase in price of exports but decrease in price of imports leading to decrease in demand for exports and increase in demand for imports. This worsens the trade balance. Thus, increasing budget deficit also increases trade deficit of the country leading to twin deficit problem.

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