CA Deficit Correction

at the end of the lesson u shud b able 2:

identify the measures

in correcting CA
Deficit

Measures to Correct CA Deficit

EXPENDITURE SWITCHING POLICIES
(Substitution effect)

oare policies attempting to switch

dd away from M towards domestic
goods.
ohappens when relative price of M
can be increased and relative
price of local X can be reduced.

1 a) DEVALUATION

means the deliberate

attempt by a govt under
a fixed ER regime to
reduce the par value of
its countrys currency
vis-a-vis other
currencies.

1b)DEPRECIATION
under the floating ER
regime, ER is determined
by free market forces of dd
n ss.
a fall in the value of a
currency in the forex
market is known as
depreciation.

devaluation / depreciation - ER
i) P x
exports become
cheaper than
competitors
Qd of X
X

ii) Pm
imports become
dearer
compared to
local goods
__ Qd of __
M

Devaluation is often taken as a last resort.

b) Devaluation
o E.g. ER before devaluation is 1 = US$2. After
devaluation, 1 = US$1.
o b4 devaluation, a British car priced at 5000
costs US$I0,000 in the USA
o After devaluation, it will only cost US$5,000.
(Uks export become cheaper)
o b4 devaluation, an American machine
priced at US$30,000 costs 15,000 in UK
o After devaluation,
it will costs ________ in UK
o (Uks import dearer)

2 ) PROTECTIONISM
a) Govt can make X
cheaper by - subsidising
exporters, tax free
holidays etc
a) make M dearer by
imposing tariffs, quotas
etc.

Protectionism
i) subsidies
Px
exports become
cheaper than
competitors
Qd of X
X

ii) Tariffs, quotas

etc Pm
imports become
dearer
compared to
local goods
__ Qd of __
M

Measures to Correct CA Deficit

EXPENDITURE REDUCING/
DAMPENING POLICIES
(income effect)

are policies aim at

reducing the income of
consumers so that they
reduce their spending on
M.

3)

DEFLATION
a) Contractionary Monetary Policy
interest rate

b) Contractionary Fiscal Policy

_ G and/or _ T

4) SUPPLY SIDE POLICY

o Improve competitiveness
of home produced goods
by improving the quality
G & S through Research &
Development (R&D) n
innovation .
o Increased productivity &
reducing cost per unit
o (Non price theory )

5) DO NOTHING???
Under the floating ER system, CAD is
automatically corrected in the long
run.
CAD ER. The countrys goods will
be cheaper n will be more
competitive causing X to rise. Its
imports will be dearer n dd for foreign
goods will fall causing M to fall.
Monetarists believes in the efficiency
of the free market.