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Reduction in Current Account Surplus and its Effects on an Economy

Discuss whether or not a reduction in a country’s trade protection will reduce its current account surplus. In assessing each answer, use the table opposite. Why it might:

Category:

International Trade and Exchange Rates

Frequently asked question

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Answer

Focus on the most significant and relevant aspects of the essay prompt.

A reduction in a country's trade protection measures can have implications for its current account surplus. Let's analyze the potential effects:
Why it might reduce the current account surplus:
➡️1. Lower Tariffs and Removal of Quotas: When tariffs are lowered or quotas are removed, the price of imported goods becomes relatively cheaper. This can lead to an increase in import expenditure as consumers and businesses take advantage of the lower prices. As a result, the gap between export revenue and import expenditure may narrow, potentially reducing the current account surplus.
➡️2. Increased Import Demand: With fewer trade restrictions, the demand for imports may rise. This can be due to consumers having access to a wider range of imported products or businesses sourcing inputs from foreign suppliers. If the increase in import demand outpaces the growth in export revenue, it could contribute to a reduction in the current account surplus.
Why it might not reduce the current account surplus:
➡️1. Limited Foreign Supply Capacity: While trade barriers are reduced, foreign firms may not have the capacity to immediately increase their supply of goods to meet the higher import demand. This could limit the growth of imports and prevent a significant reduction in the current account surplus.
➡️2. Price Inelasticity of Import Demand: If the demand for imports is relatively insensitive to changes in price (price inelastic), a reduction in trade protection measures may not lead to a significant increase in import expenditure. Consumers and businesses may continue to purchase imports at similar quantities despite the price changes, resulting in a limited impact on the current account surplus.
➡️3. Quality of Imports: The removal of trade protection measures may result in lower-quality imports entering the country. If consumers and businesses perceive a decline in quality, it could dampen import demand and mitigate any potential reduction in the current account surplus.
➡️4. Exchange Rate Effects: A reduction in trade protection measures may lead to changes in the exchange rate. If the country's currency depreciates, it can make exports more competitive and imports relatively more expensive. This shift in relative prices could offset the impact of reduced trade barriers and help maintain or even increase the current account surplus.
➡️5. Surplus on Invisibles: A country's current account surplus includes not only the balance of trade in goods but also the balance of trade in services, income from investments, and transfers. If the country has a significant surplus on invisibles, such as income earned from foreign investments or tourism revenues, it can offset any potential reduction in the trade surplus.
In conclusion, the impact of reducing trade protection measures on a country's current account surplus depends on various factors such as the responsiveness of import demand to price changes, the capacity of foreign suppliers, the quality of imports, exchange rate movements, and the contribution of invisible balances. While it is possible that a reduction in trade protection could lead to a decrease in the current account surplus, the effects can be influenced by multiple factors, and the outcome may vary depending on the specific circumstances and dynamics of the economy.

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I. 🍃Introduction
- Brief explanation of the impact of trade restrictions on imports
- Thesis statement: While lower tariffs, removal of quotas, and removal of bans/embargoes may increase imports and import expenditure, there are several factors that may limit their effectiveness.

II. Lower tariffs
- Explanation of how lower tariffs reduce the price of imports
- Potential increase in imports and import expenditure
- Limitations:
- Foreign firms may not have the capacity to supply more products
- Demand for imports may be price inelastic

III. Removal of quotas
- Explanation of how removal of quotas may result in more imports being purchased
- Potential increase in imports and import expenditure
- Limitations:
- The quality of imports may have fallen
- Other countries may also reduce their trade restrictions

IV. Removal of bans/embargoes
- Explanation of how removal of a ban/embargo will permit imports of the product to enter the country
- Potential increase in imports and import expenditure
- Limitations:
- Foreign firms may not have the capacity to supply more products
- The exchange rate may fall, raising exports and reducing imports

V. Higher import expenditure
- Explanation of how higher import expenditure may reduce the gap between export revenue and import expenditure
- Potential benefits for the economy
- Limitations:
- Export revenue may rise to match the higher import expenditure

VI. 👉Conclusion
- Recap of the potential benefits and limitations of reducing trade restrictions on imports
- Final thoughts on the effectiveness of these measures in promoting imports and import expenditure.

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• lower tariffs will reduce price of imports
• removal of quotas may result in more imports being purchased
• removal of a ban/embargo will permit imports of the product to enter the country
• import expenditure may rise
• higher import expenditure may reduce the gap between export revenue and import expenditure Why it might not:
• foreign firms may not have the capacity to supply more products
• demand for imports may be price inelastic
• the quality of imports may have fallen
• other countries may also reduce their trade restrictions
• the exchange rate may fall, raising exports and reducing imports
• export revenue may rise to match the higher import expenditure

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