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How Demand affects Balance of Payments

free economic essay on the balance of payments and the environment

 

Discuss the extent to which the use of demand side policies to achieve full employment might conflict with Balance of Payments and concern for the environment.       (15)

Demand side policies are government attempts to alter AD through using fiscal (Taxes and govt spending) or Monetary Policy (interest rates).

            To raise the level of Aggregate Demand the government could cut taxes and increase govt spending, this will give consumers an increase in disposable income therefore the C component of AD will increase. Alternatively the Monetrary Policy Committee could cut interest rates, this reduces the cost of borrowing thereby encouraging consumer spending and investment. Both policies will lead to an increase in Aggregate Demand

Full employment occurs when all resources in the economy are used, this occurs when the economy is at Full Employment (where the LRAS becomes inelastic). An increase in AD has causes Real GDP to increase, as output increases there will be an increase in demand for labour and unemployment will fall.

            If there is an increase in Real GDP there will be an increase in consumption and an increase in demand for imports, but exports are unlikely to be effected because they depend upon growth in other countries. If the value of imports increase faster than the value of exports this will lead to deterioration in the balance of payments.
The magnitude of this depends upon the marginal propensity to import, the UK has a high Marginal Propensity to Import therefore they may be a significant increase in imports.
            Also as we approach the level of full employment there is an increase in inflation. This makes UK goods less competitive therefore this will lead to a decline in exports and a further worsening of the balance of payments. The effect of this will depend upon the elasticity of the AS curve. If the AS curve is inelastic there will be a big increase in inflation and UK goods will become very uncompetitive.

            If there is an increase in Real GDP then there will be an increase in the level of consumption and production. Therefore this will lead to an increase in negative externalities such as pollution increased congestion The environment will also be damaged by the increased consumption of non renewable resources. This is an increasingly serious problem as the world may start to run out of certain commodities. Also global warming could threaten the global economy if the climate changes significantly. However economic growth doesn’t necessarily lead to serious damage in the environment. For example increased growth may lead to the development of better technologies which help protect the environment; for example cars which run on hydrogen or solar panels. However few governments actually invest any significant money in this direction. The benefits would also be quite long term

 

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