Protectionism, Gains from Trade, and Trade Balance Deficits and Surpluses - Essay Example

Explanations of concepts: Protectionism, an economic policy, aims at restricting trade between nations. The economic instruments used in this policy are imposition of tariffs, imposition of quota, and many other fiscal measures. Free trade is the opposite of the concept of protectionist policy. It is the openness of the countries in order to achieve gains from trade through mobility of goods and services between nations (Mankiw, 387-411). There are two components of trades, one is export, and the other is the import.

There are several gains that a nation can achieve from trade. In terms of economics these gains are measured in terms of the real wage and the relative prices of goods and services being traded. Real wage is measured in terms of the amounts of goods that a worker can purchase. The relative price is the domestic price of a good and service being traded as a ratio of the foreign price of the same good or service. An increase in the real wage and a decrease in the relative price indicate that the gains from trade have been achieved.

Trade between two nations contributes to the growth of GDP and GDP rate. In order to measure the contribution of trade components in the GDP, every economy maintains a trade balance accounting of its exports and imports. Whenever the volume of exports appears (measured in terms of money value) to be greater (smaller) than the volume of imports (measured in terms of money value), then there occurs a surplus (deficit) in the trade balance. When they are same, trade remains balanced. But the concept of balanced trade is used as an accounting sense; in practical it is very difficult to achieve balanced trade for any country.

Tax Cut and fiscal policy: In 2002, President Bush initiated a fiscal policy of cutting tax rates. The main aim of the tax cut was to raise the volume of private activities within the economy. This is major merit of any tax cut policy, as it raises the disposable income of people and hence demand. It also raises the volume of private savings and hence investment. This is basically the Keynesian view of this fiscal policy (Mankiw, 388-399). This decision caused USA to lose its national income by 1%.

This tax cut caused huge budget deficits and defense costs and increased the volume of fiscal deficit (Auerbach). This fiscal policy increases the budget deficit by increasing the demand for imports relative to exports and hence it reduces the volume of stock of foreign currency of the country. For the US economy this has happened. Monetary policy: Monetary policies are taken the monetary authority of the country in order to control the values of the variables like interest rates and output or income of the economy (Mankiw, 390-410).

Monetary policy includes open market operations by the government, changes in the repo rates and reverse repo rates etc. All these policies are taken to control the volume of money supply in the economy. An increase (decrease) in the money supply raises the raises (lowers) output and employment, but lowers (raises) interest rates. Money supply is determined by the amount of money in circulation in the economy and by the volume of demand deposits in the economy. Monetary policy can be used to stimulate real GDP in the short run as well as in the long run.

Increase in the supply of money can augment the demand for goods and services and hence