Policies to Connect Balance of Payment Disequilibrium

The main objective is to reduce the deficit of balance of payment Any adjustment on export and import will that is caused by the exchange rate Since the country s resources is limited, measures need to be taken to remove the deficit

Remedies
1. Expenditure Switching Policies - Action taken by government to persuade purchasers of goods and services(at home and abroad) to purchase more of that country s goods and services and less foreign goods. - Any relevant policies to persuade the domestic purchasers to buy domestically produced goods can be implemented. Suitable policies also can be used to persuade foreign purchasers to buy more exports of the particular country.

 This policy is not to reduce the total spending in a country but to re-direct or switch to your country s product than other country Outcome from this policies: 1. Fall in import expenditure 2. Rise in export and revenue 3. Fall in the supply of country s currencies and increase demand of country s currency on the market.

 Expenditure switching policies include: 1. Tariffs 2. Quotas 3. Exchange controls 4. Export subsidies

Expenditure Dampening/Reducing Policies

Any action taken by the government that is designed to reduce the total spending level in an economy 2 types of effects in theory: 1. A reduction of spending there will be fewer purchases of imported goods 2. Domestic producers will find that their domestic market is dampened and is more hard to sell in they will try to increase sales abroad leads to fall in import and increase of export.

 Expenditure dampening policies: 1. Deflationary fiscal policies Raising taxes and reduce government expenditure. Increase taxes will reduce disposable income meaning less will be available to spend on imports. It all depends on the marginal propensity to import. A high marginal propensity to import would mean that a fall in disposable incomes will have a great impact upon import spending. taxes need not have to be raised by much to reduce Example: For example, if a household earns one extra dollar of disposable income, and the marginal propensity to import is 0.2, then of that dollar, the household will spend 20 cents of that dollar on imported goods and services.

Example :The UK government assumes that UK citizens have a high marginal propensity to import and thus will use a decrease in disposable income as a tool to control the current account on the Balance of Payments. - High value of marginal propensity to import what will happen??

Deflationary monetary policy

Raising interest rates and reducing the money supply what will be the outcome?? Disadvantages of managed exchanged rates creates a deflationary situation when there is a downward pressure on the exchange rate as a results of a balance of payment deficits. Deflationary outcome-reduce spending on imports negative effect of reducing spending on home produced products leads to unemployment.

Marginal Propensity to Import

The marginal propensity to import (MPM) refers to the change in import expenditure that occurs with a change in disposable income (income after taxes and transfers). For example, if a household earns one extra dollar of disposable income, and the marginal propensity to import is 0.2, then of that dollar, the household will spend 20 cents of that dollar on imported goods and services.

Marginal Propensity to Import

Mathematically, the marginal propensity to import (MPM) function is expressed as the derivative of the import (I) function with respect to disposable income (Y).

Marginal Propensity to Import

In other words, the marginal propensity to import is measured as the ratio of the change in imports to the change in income, thus giving us a figure between 0 and 1. Imports are also considered to be automatic stabilisers that work to lessen fluctuations in real GDP Example: The UK government assumes that UK citizens have a high marginal propensity to import and thus will use a decrease in disposable income as a tool to control the current account on the Balance of Payments.

Marginal Propensity to Import

In economics, the marginal propensity to consume (MPC) is an empirical metric that quantifies induced consumption, the concept that the increase in personal consumer spending (consumption) that occurs with an increase in disposable income (income after taxes and transfers). For example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35 cents.