2008 B Macro FRQ #1
(A) Will each of the following groups benefit from the decrease in the tariff rate?
(i) Mexican consumers
If the Mexican government reduces the tariffs (tax) on cars being imported from other countries then importers will be able to sell those cars for less. This means Mexicans will be able to buy cars at a cheaper price and be able to spend the surplus savings on other goods like, education, healthcare, entertainment, food, clothing. Yes, I would say that this is a benefit.
(ii) Mexican automobile manufacturers. Explain.
No Mexican automobile manufacturers would like tariffs to be higher not lower. If tariffs were higher then the Mexican manufacturers would be able to raise the prices of their domestically produced cars. Mexican automobile manufacturers would not benefit.
If tariffs are reduced then importers can charge less for each car. Consumers will be able to buy cheaper cars. Domestic producers of cars will have to lower their prices to compete with the imports.
(B) How would the decrease in the tariffs rate affect each of the following in Mexico?
(i) Current Account Balance. Explain.
We must first know what the Current account is.
If the current account balance is (imports & exports) goods and services.
If Mexico lowers its tariffs on automobiles imported then the price of imported automobiles will fall and more automobiles will be imported. Therefore their will be a current account deficit as imports will be increasing relative to exports..
(ii) Capital (financial) account balance.
If the current account is in a deficit, and therefore the capital account must be in a surplus.
Think of it like this - If you buy food from the grocery store you have imported goods into your household and therefore your current account is in a deficit. When you paid for the food you bought at the store that money is counted in the financial (capital account). The grocery store will take this cash and spend it at your advertising firm by buying your services.
When Americans buy cars from Germany our current account goes into a deficit but we paid for the cars with cash, and this cash will be used to buy property and goods from America.
(C) Given the change in Mexico's current account in part (B)(i), what will happen to the aggregate demand in Mexico.
If Imports increase then net exports must decrease and therefore AD will decrease as Net exports is a component of AD.