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Other than depreciation in exchange rate discuss which solution to a balance of trade is best.

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Introduction

´╗┐Other than depreciation in exchange rate discuss which solution to a balance of trade is best. The balance of a trade is the difference between a country?s imports and exports; it is the largest component of a country's balance of payments. Governments implement various polices to improve the balance including: trade restrictions, improvement in supply side policies and deflationary demand management. Governments may apply tariffs; taxes on imported goods, or quotas; physical restrictions on the number of goods coming into a country. Trade restrictions on various imports will cause prices to rise relative to domestic goods and so the demand for imports should fall and demand for domestic goods should rise, due to consumers turning to cheaper alternatives, leading to an improvement in the balance of trade. However overall, domestic consumers will face higher prices, which also means that there is a loss of consumer surplus and an overall net welfare loss as consumers pay higher prices for goods. There is also a domestic producer surplus as producers are protected from cheap imports, and receive a higher price than they would have without the tariff. ...read more.

Middle

By increasing taxes people?s income will be reduced and they will have less money to spend on goods and services, as a result aggregate demand will fall and demand for imports will decline, improving the balance of trade. Increasing interest rates will encourage consumers to save and discourage them to borrow money by increasing the price of borrowing, therefore there is less spending and demand for imported elastic goods falls. An overall decline in consumer spending will lead to the general price level to drop, this will increase a country?s international competitiveness as their goods become relatively cheaper compared to other countries and therefore more desirable leading to demand for exports rising. As consumer demand drops domestically, firms will be left with a surplus of output, this can alternatively be exported to other countries and as a result improve the balance of trade. However, if a country heavily imports goods such as oil, coal and gas, which are largely inelastic, meaning demand for them remains relatively unchanged regardless of a change in people?s incomes or price, then increased taxation and interest rates will have little affect on the demand for imports and consequently little affect on the balance of trade. ...read more.

Conclusion

Governments may also offer subsidies to firms in order to reduce their costs of production, enabling them to sell their goods at lower prices. Subsequently, domestic firms will become more internationally competitive as their prices will be relatively cheaper or their products will be more desirable and so demand for exports will rise, resulting in a reduced trade deficit. However if industries do not expand quickly enough or provide sufficient advancements, so as to see a return on investment then such policies may be unsustainable. Similarly, if the government is subsidising an industry that is being out competed international and as a result there is structural decline, then this is merely a short-term solution, which does not solve the underlying issues. The most effective solution to a balance of trade is to introduce long-term supply-side improvements that improve a country?s productive potential. Protectionism is a short-term solution that will most likely bring around retaliation from other countries. Expenditure dampening reduces standard of living and can cause negative economic growth and unemployment. Although, supply-side polices can be costly to the government, by increasing the ability of a country to manufacture and produce goods, which in turn it can export at competitive prices, is the most effective solution to a trade deficit. ...read more.

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