Government Policies influencing demand & international trade Q2

Thomas Sim PEA2066

Q.
a) Discuss the following government policy in influencing domestic demand in the country.

i) Fiscal policy (4 marks)
ii) Monetary policy (4 marks)
iii) Direct Control Policy (4 marks)

b) Explain two (2) main factors supporting the International Trade. (8 marks)

(20 marks, 2017 Q2)

A.
a) Influencing domestic demand.

i) Fiscal policy - Fiscal Policy refers to the regulation of the level of government spending, taxation and public debt. By tax cuts, rebates and increased government spending, this expansionary policies from central banks will increase the money supply in the economy. People with more money as tax is cut, and getting employment from government spending will consume more. This then spurs the domestic demand.

ii) Monetary policy - The central bank can regulate the money policy by increasing in the money supply and reduce interest rates. A decrease in the discount rate, and a decrease in reserve requirements will make money supply more in the economy. This is expansionary monetary policy - an increase in the quantity of money in circulation, with corresponding reductions in interest rates, for the expressed purpose of stimulating the economy to generate growth.

Monetary policy can be undertaken by printing more paper currency. In modern economies, monetary policy is undertaken by controlling the money creation process performed through fractional-reserve banking.

The Federal Reserve System (or the Fed) is U.S. monetary authority responsible for monetary policy. In theory, it can control the fractional-banking money creation process and the money supply through open market operations (buying U.S. Treasury securities), a lower discount rate, and lower reserve requirements. In practice, the Fed primarily uses open market operations for this control.

An important side effect of expansionary monetary policy is control of interest rates. As the quantity of money increases, banks are willing to make loans at lower interest rates. Then, people with less motivation to keep money in the bank (as interest is low), will spend the money to create demand.

iii) Direct Control Policy - “Direct controls” refer to any measure of governmental intervention which is directly aimed at increasing or decreasing some particular group of payments or receipts in the balance of payment. As means of improving a country’s Balance of Payment (BOP), the government may resort the:

  • (i) Complete prohibition of certain luxury imports into that country and
  • (ii) A general deflationary financial policy designed to reduce the general level of money incomes and prices in that country.
The former is a direct intervention in one small item of the BOP; the latter exerts its influence on the general economic situation. 
The former is quantitative control which pays no regard to the price mechanism; the latter works through its effect upon relative money prices and money incomes. Import and export duties and subsidies on particular products are certainly examples of direct controls.
For example, by removing subsidies on manufacturing of national car project, the car price will increase. On the other hand, by giving subsidy and restriction of import of car from outside, it will create demand for national car. This in turn spurs employment, and people will be richer to spend.
Ref:
http://www.economicsdiscussion.net/balance-of-payment/direct-controls-of-government-of-bop/6601

b) 2 main factors supporting the International Trade

Benefits of International Trade – Advantage of international trade

  1. Monetary gains to the respective country indulging in trade.
  2. More variety of goods available for consumers.
  3. Better quality of goods.
  4. Competition both at the international level as well as local level.
  5. Closer ties between nations.
  6. More exchange of technical know-how.
  7. Local producers will try to improve the quality of their products.
  8. Increase in employment locally.
Ref:
http://www.paggu.com/business/world-economy/why-international-trade-advantage-and-disadvantage/