Assume that a country is at full employment and wants to improve its trade deficit by devaluing its currency. Using the absorption approach which of the following methods will improve the trade deficit?
I. Decrease government spending
II. Decrease consumption taxes
III. Decrease income taxes

Question

Quizplus · Accepted Answer

According to the absorption approach, a devaluation of the currency will increase exports and reduce imports. However, if the economy is already at full employment, an increase in exports cannot be met by an increase in production capacity, leading to inflationary pressures. Therefore, reducing government spending, which reduces the demand for goods and services in the economy, would be more effective in reducing imports and improving the trade deficit than reducing taxes, which would increase demand and potentially lead to inflation.

Assume That a Country Is at Full Employment and Wants