Question 1

There are the three reasons why aggregate demand is downward slope: real wealth effect, interest rate effect, exchange rate effect. In a case scenario the market saw an increase in consumer spending when there is a boom in economy. Or the economic crisis makes the public bit shy to buy or consume any product. In the above two situations: the transfer payment does not make the part of government spending as the public will spend the money given as self-security and unemployment. Export situation gets worse as the foreigners are reluctant to buy expensive goods and the government will make some imports. The borrowing has become easy and loans are issued at a cheaper rate to buy car.

Following the equation: Y = C + I + G + NX will the below examples increase or decrease the aggregate demand in Pakistan? What will be the shift in position for below situations?

1)Widespread fear of recession

2)The appreciation in the Pakistani Rupee rate

3)A boom in the stock market

4)An increase in transfer payment

5)A decrease in real interest rate in Pakistan

ANSWER

Question 2

How would you define price stickiness? How does this phenomenon lead to an increase in the short run level of output according to the Keynesians? Comment

ANSWER

Question 3

Read the given case study and answer the questions given below,

Pakistan ranked 8th in size of trade deficit

The tenure of the previous government, from 2013 to 2018, witnessed a skyrocketing current account deficit as it increased from $2.5 billion in FY13 to $18.9 billion in FY18.

The major driver was the trade deficit, which widened from $19.2 billion in 2012 to $35.6 billion in 2017, according to data extracted from the ITC's Trademap.org. Imports increased from $43.8 billion in 2012 to $57.4 billion in 2017 and exports decreased from $24.6 billion in 2012 to $21.9 billion in 2017.

Between July 2014 and June 2015, REER had increased by 8.83%. It increased by 5.54% in the prior fiscal year, FY14. In simpler terms, the rupee was kept above its equilibrium value between June 2013 and June 2018, making it cheaper to purchase goods from other countries. Furthermore, exporters lost their competitiveness against foreign competitors in the global market.

Today, with the rupee closer to its equilibrium value, exports have increased. This has positively impacted the trade balance, alleviating some of the concerns regarding the burgeoning current account deficit.

First, let us examine how the severe trade deficit for Pakistan, as reported by Trademap.org, is relative to other countries experiencing large trade gaps. With a deficit of more than $35 billion, Pakistan was ranked eighth in terms of the size of the trade deficit in 2017.

The trade deficit of Pakistan exceeds the total value of its exports. Even though the trade deficit was skyrocketing, the exports and imports (goods and services) as a percentage of GDP, as reported in the World Development Indicators by the World Bank, was the lowest for Pakistan in the region. Even with relatively higher levels of imports, the lack of exports has turned Pakistan into a relatively closed economy within the region.

The lack of export growth to accompany the high rate of import growth is a serious cause for concern. Pakistan had a trade deficit of $13.9 billion with China and $6.7 billion with the UAE in 2017. Moreover, it had a trade deficit of more than $1 billion with nine countries including Saudi Arabia, India, Thailand and Japan. In 2013, the trade deficit with China was $4 billion. Hence, the increase in CPEC-related imports was by far the most important factor in the rising trade deficit.

Trade deficit shrinks as exports grow faster than imports

Exports of goods and services as a percentage of GDP for Pakistan have declined from 12.4% in 2012 to 8.2% in 2017, the lowest amongst major economies in the South Asian region. Exports of textile products, which have the largest share, have hovered around $13 billion. Bangladesh and Vietnam increased their textile exports by more than 70% during the same time period.

Both Vietnam and Bangladesh imported textile machinery at 145% more value than that for the textile machinery imported by Pakistan in 2017. Since 2010, imports of textile machinery into Pakistan have remained stagnant.

It is important to note that Pakistan was one of the top five importers of textile machinery in 2005. Bangladesh and Vietnam import primarily knitting machinery, while Pakistan imports mostly spinning machinery involved in upstream production.

'Fourth industrial revolution to reshape govt, trade and health'

As Pakistan is a large cotton-producing country, investments in upstream textile production, such as cotton yarn, is likely. However, there is an urgent need to increase investments in downstream high value-added exports in the textile industry, such as garments and other finished products. The increase in exports in FY18 was primarily due to the utilisation of idle capacity in the textile sector.

The United Nations Conference on Trade and Development's (Unctad) trade and development report 2018 predicts higher levels of uncertainty in global trade may disrupt trade volumes. Higher levels of tariffs are likely to have consequences for income distribution and aggregate demand.

However, Pakistan can seek to attract foreign investment that is likely to be relocated from such countries. In summary, the government must adopt the right set of policies to attract investment and tackle the current account deficit.

(Published by the Express Tribune, 29 October, 2018)

Answer the following questions after reading the case given above,

1)What are the likely reasons of large trade deficit in Pakistan?

2)How would you compare the trade of Pakistan with other countries in the region?

3)What measures can be taken by the government to correct the trade deficit?

4)Is Pakistan a closed economy in terms of trade? Comment.

ANSWER