Suggested Answers of BT2 Revision Package - ASKnLearn

aggregate demand in U.S. and decrease production through the multiplier effect. Nationalincome will thus fall by a multiple amount and cyclical unemployment will rise considerably.A country that loses its comparative advantage will also experience a rise in structuralunemployment which could take a longer time to remove. For example, with an increase indemand for low cost imports from China, US firms producing labour intensive manufacturinggoods such as mobile phones and textiles, suffer from the increased competition whichresults in higher unemployment. In addition, the effects of outsourcing operations from U.S.to low cost economies like China and Vietnam has worsened the unemployment problem(structural).External effects of a BOT deficitThe U.S. government needs to maintain a healthy BOT. A persistent or prolonged BOTdeficit means that the country has been depleting its foreign reserves and/or resorting toexternal borrowing from the organisations such as the International Monetary Fund orthrough the issue of government bonds and selling them abroad.The US may run the risk of exhausting all its reserves or they may accumulate large amountof external debts. This has an adverse effect on its economy due to large debt repayments infuture years which is a burden for future generations. There is also a huge opportunity costas funds used to repay debts could be utilised to improve productive capacity and promoteeconomic growth instead. In addition, in the recent years, foreign countries are less willing tobuy US government bonds to finance their trade deficit. Debtor countries like China andJapan may question the ability of the U.S. government in paying back these debts. It mayalso result in higher borrowing costs for the U.S.Explain how external and internal value of money is affectedAs export earnings fall, the demand for US dollar will fall while a rise in import expenditurewill increase the supply of US dollar in the foreign exchange market. Therefore, US dollar willdepreciate. As the US dollar depreciates, the resultant imported inflation, higher cost ofliving; higher costs of production will all act as a deterrent to potential foreign investors to theUS. This will be detrimental to US actual and potential growth.Explain the implications of the capital accountForeign Direct Investments (FDI) into U.S. might be falling as other emerging economiescompete for these FDI. Also, the global recession could be weakening the confidence offoreign investors in U.S. Instead Asia’s growth might be more optimistic and FDI arechannelled into Asia. Hence, the capital inflow to the capital account might not be sufficientto offset the BOT deficit, triggering the implications of a BOT deficit as discussed above.