Economics study notes

Section 5
When a country is faced with a persistent BOP surplus, the following situations could develop:
* A revaluation or an increase in the value of a local currency if its value is determined by the
market forces of demand and supply.
* An increase in the price of locally produced goods in export markets which would
consequently reduce a nation's competitiveness with its former trading partners.
This could result in locally based export-oriented industries contracting with unfavourable
consequences, as former trading partners could cause locally based export-oriented industries to
contract to the point where production levels, and eventually employment levels, must be
reduced.
* A tendency toward inflation if the economy was in equilibrium at its full potential before the
BOP surplus situation developed.
A persistent BOP deficit can give rise to the following:
* A decline in the value of the local currency if it is assumed that that value is determined by the
market forces of demand and supply.
* An increase in the prices of imported goods and services. If these include such goods as oil and
lubricants, then a significant contractionary impact on the economy results. This is so since costs
of production within the economy will rise, which causes aggregate supply to decline. This then
results in:
• an increase in price levels and injections
• a decline in employment
• a decline in GDP
• the creation of inflation
• a general decline in the economy's performance.
Promoting Growth and development
The economies of Caribbean countries can be described as developing economies.
They all - to varying degrees - manifest the characteristics which include the following:
* low income levels
high unemployment levels significant poverty levels
* low levels of productivity
* inadequate resources; financial, as well as, human and natural.
Maintaining an Economy's Potential Output
Market-based economies are ever so often affected by what is known as the business cycle. The
business cycle refers to fluctuations in the level of economic activity within an economy.
Recessionary and Inflationary Gaps
Since government policy makers wish to ensure that an economy performs to its potential, this
suggests that there are times when an economy is not performing at its potential.
When an economy is not performing at its potential then it may be performing either below its
potential, or above its potential. In the case where an economy is performing below its potential,
its level of real GDP is below that which policy makers desire it to be, or we may say there is a
recession.
This is also known as a recessionary gap. Apart from the shortfall in real GDP, there are other
factors which will have an impact, and are evident, on an underperforming economy.
These are:
* low levels of business activity
* unemployment
* a fall in income
* a rise in poverty.
Ways Governments Reduce Inflation and Relieve Recession
Remedying an Underperforming Economy
Government policy makers in this circumstance will put in place measures which will create
demand within that economy. Such measures include an increase in government spending, a
reduction in taxation levels on households and businesses or a combination of the two.
As a result of taking such measures, the following is likely to occur:
* increased employment levels
* increased income levels
* increased spending in the economy
* increased levels of output from the economy as the recession is eliminated.
Stagflation is the simultaneous occurrence of unemployment and high levels of inflation.
Remedying an Over-performing
Economy
Is it really possible that an economy can over perform? Absolutely! When this occurs, it is
because of excessive levels of spending within that economy. Such development would require
measures we discussed earlier when we dealt with how fiscal policy influences the price level
within an economy. As a reminder for you, these included a reduction in government spending
and/or, an increase in taxation on household and business incomes. By taking such action the
following is likely to occur:
* A decline in household disposable income, which is the income that households have available
for spending following taxation
* A decline in business income, which are profits after these would have been taxed
* An overall decline in government spending
* A decline in GDP and price levels, back to desired levels
Major Influences on Growth
The major influences on economic growth are:
* The levels of investment in the economy - The levels of investment in the economy.
Earlier, we stated that investment involved purchases by businesses of new capital, including
buildings, machinery, equipment, and so forth. This investment is only made possible when there
is savings taking place within the economy. The sources of savings in an economy are
households, businesses, government etc.
* The quantity of production resources available within the economy - The quantity of
productive resources available within an economy is another important influence. In one of our
earlier chapters, we discussed these productive resources which include such resources as labour,
capital, natural resources and other essential inputs. Productive resources are relatively scarce
throughout the world, and the Caribbean is no exception.
* The size of the nations population - The size of a nation's population needs to be at an optimum
level in order to foster growth. Recall that labour is a productive resource that is needed for
production to take place. Given the number of available resources and state of technology
existing within a nation, a population size which is too small or large will hinder growth.
What Governments can do to Foster Economic Growth
A government's role in encouraging growth may be compared to that of a conductor directing an
orchestra. In this regard, a government would be providing the necessary stimuli to the various
productive sectors. When a government seeks to encourage economic growth, it is embarking on
a long-term project that must be pursued over many years.
Attract overseas investment
Above, we outlined that developing countries lack the capital to invest in research and
development. In order for developing countries such as those in the Caribbean region to
undertake any major endeavour in technology, the government would need to attract investment
from overseas.
Retention of educated and skilled citizens
The government of a developing country must develop imaginative ways of retaining its
educated and skilled citizens.
Perhaps one of these could be in relation to generous housing allowances and other such
inducements which improve the living standards of its professionals at home, hence reducing the
pull or allurement to more overseas.
Subsidize education and relevant skills training
Many developing countries suffer as a result of the low productivity of their labour force. To
counteract this, a government can subsidize education and relevant skills training, which means
making this fully or partly paid for on behalf of citizens. Such a measure has the potential to
improve workers, and an economy's, productivity as a whole.
Maximization of resources
In many instances, it is evident that resources are wasted in developing countries. Therefore
governments must ensure that resources are maximized in terms of their utilization.
Opportunities for conservation and recycling, in terms of natural resources, should be taken
advantage of in order to be more efficient in the use of these resources.
Budget
You may recall that a government has an annual financial plan which is called a budget. A
considerable part of the funds used to finance a government's budget is received from taxes
collected from residents of a country. There are times, however, when sufficient funds cannot be
raised from taxes to finance all the projects a government wishes to undertake within its budget
period; then the government must use up funds from other sources.
This is especially true for developing countries, where some of these funds come from loans
obtained from other nations and international financial agencies, for example, the International
Monetary Fund.
Budget Deficit versus Budget
Surplus
When a government spends more than it has received in tax revenue, a budget deficit or fiscal
deficit results. If the government has spent less than it has received in tax revenues, then it is
running a budget surplus.
A country's national debt is the accumulated amount of budget deficits (minus any surpluses)
over time; put another way, it is the total amount of another way, it is the total amount of
government borrowing.