“Suppose a growing world with positive real income andeconomic growth. There are
ID: 1244340 • Letter: #
Question
“Suppose a growing world with positive real income andeconomic growth. There are some lower income countries producinggoods for basic necessities of life. If income of the poor peoplebelonging to lower income countries increases, they move towardsthe luxurious goods like cars and air conditioners etc. Since,income elasticity of luxurious goods is positive i.e. as incomeincreases; demand also increases. So, with the increase in income,demand of luxurious goods from abroad will increase because suchtypes of goods are not produced domestically in lower incomecountries.”
Required:
Keeping in view the above scenario, what will be the effect ofhigh demand of luxuries goods from abroad on the balance of paymentof lower income countries?
Explanation / Answer
The effect of high demand of luxuries goods from abroad on the balance of payment of lower income countries will be negative, because imports will exceed the exports of the country. Which is sign of deficit balance of payment.
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