A persistent deficit can be corrected by making home goods more attractive, by cutting spending, or by raising productivity.
Three ways to correct a deficit
Expenditure switching
Make home goods cheaper than foreign ones: a depreciation or devaluation, tariffs, export subsidies.
Expenditure reducing
Cut AD with contractionary fiscal or monetary policy: lower incomes, fewer imports.
Supply-side policies
Raise productivity so exports compete on cost and quality.
The points to remember
- Write it like this: "Expenditure switching moves spending from imports to home goods; expenditure reducing cuts total spending, so imports fall."
- Supply-side policies work best but slowest.
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A depreciation helps only if buyers respond enough. The Marshall-Lerner condition: PED of exports + PED of imports > 1.
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The points to remember
- Short run: demand is inelastic (PEDs sum < 1): the deficit widens.
- Long run: demand is elastic (sum > 1): it improves.
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No method is free.
How well each works
| Method | Works when | Limits |
|---|---|---|
| Depreciation | Marshall-Lerner holds | J-curve first; inflation |
| Tariffs | Imports have close home substitutes | Retaliation; WTO rules |
| Contractionary policy | Imports are a large share of spending | Lower growth and jobs |
| Supply-side | Given years to work | Slow; costly |
The points to remember
- A Paper 3 recommendation: choose one method, back it with the data, then weigh its limits.
- Compare it with one other method to show the judgement.
Paper 2 asked this in May 2023, for 4 marks.
Text A says that after the peso depreciated, the balance of trade deficit first widened and later turned into a surplus.
Using a J-curve diagram, explain the likely reason.
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See the answer broken into clear points, with guidance on how each point earns marks.
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How the 4 marks are given
| Marks | What your answer needs |
|---|---|
| 3–4 | A correct diagram and a correct explanation |
| 1–2 | A correct diagram or a correct explanation, not both |
| 3 at most | A diagram with a wrong or missing label |