MOUNT KENYA UNIVERSITY

CAT BED1201- INTRODUCTION TO MACROECONOMICS

JAN/APRIL 2021

1. State and explain the methods that can be used by a country to correct the trade deficit (10 marks)

Trade deficit occurs when the value of imports is greater than the value of exports.

The following are ways of correcting the trade deficit;

Consume less and save more -This means that increasing consumption taxes to be like those that nearly all other
countries in the world have will help reduce the trade deficit, by discouraging consumption, increasing saving, and
reducing the government deficit.

Imposing Import Quotas-Import quotas may reduce value of imports. This refers to restricting the

amount of goods imported by a country. This will help to correct trade deficit.

Tax capital inflows. This involves imposing more taxes on the borrowing done from abroad. This will make citizens
to borrow less. This will help to reduce trade deficit.

Global Recession-This refers to a case where global economy is in recession making the demand for export to fall
therefore correcting the trade deficit

Supply Side Policies – This refers to using those policies aim at improving the productivity and competitiveness of
the economy therefore making a country to increase its exports hence increasing its helps exports.

Reducing the exchange rate (devaluation or depreciation) -Reducing the value of the exchange rate can help to reduce
a trade deficit. A depreciation also makes imports more expensive therefore reducing demand for imports hence
reducing importation. This will therefore, we would expect improve the trade deficit.

Deflationary fiscal policy. This involves higher tax and lower government spending. Higher tax reduces consumers’
disposable income leading to a decline in consumer spending and less spending on imports. Also, the deflationary
fiscal policy helps reduce inflation and thereby improve the competitiveness of exports. This will reduce trade deficit.

2. National income accounting is very paramount to any country that is conscious about its
growth and development. Discuss the national income difficulties in estimation of national income (10marks)

Difficulties faced in estimating national income

Unreported Illegal Income:

This refers to unreported illegal income earned by those people engaged into those parallel economy which is not
included in the national income estimates of our country. This may not be factored in by government in calculating
its income.

Choice of method to use in calculating the income:

The selection of method while calculating National Income is also an important task. The wrong method used to
calculate national income leads to failure to estimate national

Lack of reliable information:

Most producers may not have an idea of the quantity and value of their output. They may also fail practice of keeping
regular accounts. This will make it hard for the government to get information to estimates its income.

Income lack of adequate data:

The lack of adequate statistical data makes the task of estimation of national income more difficult. If the government
lacks adequate information on what is to be taxed and other sources of its revenue then it will be hard to estimate its
income

Lack of differentiation in economic functioning:

Lack of occupational specialization makes it difficult to know what one earns. This is because one may be

paid in his white-collar job as well as his farming and his other manual work. This makes it difficult for

the government to estimates its income.

Double counting: Double counting is also a major problem while calculating national income. If the value of

all goods and services totaled, the total will overtake the national output, because some goods are

currently consumed being used in the making of others. The best way to avoid this error is to calculate only

the value of those goods and services that enter into final consumption.

Problems of definition: This refers to problem of identifying goods and services that need to be taxed.

Generally, the country should include all goods and services produced in the course of the year in what is to be taxed,
but there are some services which are not easily evaluated inform of money, e.g., services of shamba boy and hose
help girl.

3. Discuss some of the options that can be used by Kenyan government in dealing with excess money in circulation
(10 marks)

Options that can be used by Kenyan government in dealing with excess money in circulation
Changing the currency-Sometimes inflation arises when the currency loses value. At this point when citizens have
lost trust in a currency, it could be important to present another currency or utilize another like the dollar as in the
case of example Zimbabwe’s excessive inflation.

Supply Side Policies

Often inflation is caused by persistent uncompetitiveness and rising costs. Supply-side policies may enable the
economy to become more competitive and help to moderate inflationary pressures. For example, more flexible
labour markets may help reduce inflationary pressure.

Open market operations – This is where the government sell government securities through the Central Bank as
away of collecting back money from its citizens. This reduces money in circulation hence reducing inflation.

Raising of bank rate -The government through central bank can instruct banks to raise interest rate charged on
loans to its customers. This will help the government reduce the money in circulation thus reducing inflation.

Raising margin requirement -This involves raising the value of assets required as security for loans. This will reduce
the number of people who qualify to borrow in a bank hence reducing inflation

Selective credit control -this involves freezing lending to some sectors of the economy. This will reduce the amount
of money in circulation and thus reducing inflation

Increase compulsory deposits made by banks to the central bank-This is where bank is forced to deposit some
money in central banks as away of reducing money that they can lend out. This will reduce money in circulation
hance reducing inflation.