Page 263 - DECO402_Macro Economics

Macroeconomic Theory

Notes

Did You Know? Deficit in balance of payment means excess of expenditure over income.

Assumptions

This model is based on these assumptions that (a) Trade restrictions do not exist (b) capitalist do
not exist and; (c) productivity, terms of trade and other financial transfers are given. In figure 29.1,
horizontal axis measures the real domestic expenditure and vertical axis expresses the cost ratio
which is the indicator of relative costs and shoes the competitiveness of the economy. Any movement
towards left (towards 0) on the horizontal axis means use of expenditure reducing policy and any
upward movement on vertical axis means use of expenditure switching policy. FF is the internal
balance curve which expresses the situation of full employment. It shows various combinations of
cost ratio and real domestic expense. A given level of employment can be obtained by either a level
lower than a very favourable relative form of cost ratio and domestic expenditure or by a level upper
than a less favourable relative form of cost ratio and domestic expenditure. In this way curve FF
bends towards the right. Clearly, part towards the right of curve FF (upper) is related to inflation of
situation of more than full employment and part towards the left of curve (lower) expresses recession
or unemployment.

Self Assessment
Multiple Choice Questions:
3. Objective of expenditure reducing policies is to ............ all demand by the medium of more
taxes and interest rates
(a) reduce (b) add
(c) increase (d) none of these
4. it is important for the success of economic policy that number of policy equipments is equal
to ..............
(a) number of policy objectives (b) objectives
(c) policy (d) equipments
5. If economy is at full employment level then because of the policy of devaluation there may
be ............ in the economy.
(a) deflation (b) inflation
(c) loss (d) decrease
6. Theory of economic (monetary or fiscal) policy has ........... around two separate problems.
(a) collected (a) centred
(c) discreet (d) none of these.
Curve XX shows the external balance where in lack of capitalists, export is equal to import. That is
why, external balance happens when net exports become zero. This curve grows from left to right side
which means that for economy to stay in external balance should definitely equilibrium devaluation
by increase in domestic expenditure. (Devaluation, by encouraging export and discouraging import
will improve the trade balance of the country and increase in real domestic expense will increase the
import of the country in sufficient quantity). Clearly, part above the curve XX is related to saving and
the part below it shows the deficit of balance of payment.

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