Question

3. The Chinese government is expected to increase military spending in 2017 to counter President Trump’s increased defense spending policies.

a. Explain in macroeconomic measurement, modeling, and movement terms how this action will affect GDP and inflation in China in the Chinese Transactions sector and the Chinese Money sector.

b. Explain how increases in military spending in China could affect the economies of other countries using macroeconomic measures, models, and movement cycles. State at least two different perspectives on what the changes will mean.

Answer 1

a. An increase in defense spending in China will mean that aggregate demand will increase over time as a component of aggregate demand in the form of government spending is increasing. As the AD curve will shift rightwards this willl mean that the price level in the economy will increase and so the inflation level rises as well. The Chinese transaction sector will experience an increase in volume and also spare parts and other ancillary industries which cater to the Chinese defense industry will also benefit and experience increased sales. The level of money supply as per the quantity theory of money will also increase in China as level of spending increases. The Chinese money sector will benefit from increases in volume. Also as investment rises the economy will move to a new steady state as per the Solow model as the production function shifts upwards.

b. As the Chinese defense spending increases then this will mean that imports of spare parts from other countries to increase and this cause other countries industries to thrive as well as Chinese defense spending increases. The exports of other countries will thus increase as they send the spare parts needed in China for new equipment. The balance of trade in trading countries will thus improve while they worsen at home.