CAIE A-Level Economics 11.1.2 Policies & balance of payments

The use of tariffs is the most effective way to correct a balance of payments deficit.

With the help of a diagram, evaluate this statement

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content

Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

- Tariffs should be clearly explained as a tax on selected imports and such taxes will act as a barrier to free trade

- The key elements of the balance of payments accounts should be briefly outlined

- A balance of payments deficit should be explained and linked to its potential effects on a country's exchange rate.

- An accurate, clearly labelled diagram should be provided which would form the basis for analysing the impact of a tariff on the balance of payments.

- The focus of the analysis should be on the recognition that tariffs represent an expenditure switching policy which will rely significantly upon the response of the demand for imports in relation to a change in the price of imports.

- Also, the analysis should recognize the overall impact of an increase in tariffs will be primarily upon the goods and services element of the balance of payments current account.

No diagram Max L3-Micro diagram not acceptable

5

AO3 Evaluation

- Tariffs often produce a retaliation response by those countries which have to pay the tariff. This might significantly reduce the positive impact upon the balance of payments.

- The benefits of imposing a tariff regarding a balance of payments deficit will also be determined by the nature of the balance of payments deficit. Although tariffs might be suitable for a long-term, persistent deficit, alternative policies might be more effective for short-term, more temporary situations.

- Alternative methods of addressing the balance of payments deficit may be more appropriate. For example, an economy experience high inflation might use a more effective expenditure reducing policy to correct this deficit.

- The net effect on the current account will also be determined by the elasticity of demand for imports. Imports which are deemed inelastic will increase, rather than reduce total expenditure on imports when the price of imports rises.

- Other potential negative effects on the economy also need to be considered. For example, the loss of producer and consumer surplus.

- A conclusion might attempt to form an overall judgement on the short term and long-term impact on the balance of payments.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation