Nordavia is a small economy whose main export is copper. Global copper prices rise sharply on world commodity markets, significantly increasing the revenue earned by Nordavia's copper exporters, with no change in government policy. (a) Explain how this rise in copper export reve…

Answer: ((a)) Higher copper export revenue raises the incomes of copper exporters, who hire more workers directly, and the extra spending this generates raises demand for labour in other sectors too through the multiplier process, so demand-deficient unemployment falls ((b)) Rising incomes and spending across the economy raise aggregate demand, and if Nordavia is already close to its productive capacity this creates demand-pull inflationary pressure, so the rate of inflation is likely to rise ((c)) The higher copper export revenue is itself a credit item on the current account, so, provided import spending does not rise by an equal or greater amount, Nordavia's current account balance improves. Part (a): Effect on unemployment The rise in world copper prices means Nordavia's copper exporters earn more revenue for the same volume of output, and they respond by expanding output and hiring more workers directly in the mining and exp…

A2 Economics 9708: How an Export Boom Affects Unemployment, Inflation and the Current Account

Part (a): Effect on unemployment

The rise in world copper prices means Nordavia’s copper exporters earn more revenue for the same volume of output, and they respond by expanding output and hiring more workers directly in the mining and export sector. The extra income earned by these workers and firms is then spent in the wider economy (on housing, retail, transport and other services) raising demand for labour in those sectors too, through the multiplier process. As firms across the economy face higher demand for their output, they take on more workers, so demand-deficient (cyclical) unemployment falls.

Part (b): Effect on inflation

The same rise in incomes and spending that reduces unemployment also raises aggregate demand throughout the economy. If Nordavia’s economy is already operating close to its productive capacity, firms find it increasingly difficult to expand output further without bidding up the price of scarce labour and other resources. This creates demand-pull inflationary pressure, so Nordavia’s rate of inflation is likely to rise as a result of the export-driven boom in aggregate demand.

Part (c): Effect on the current account of the balance of payments

Copper exports are a credit item on Nordavia’s current account, so a rise in the price at which the same volume of copper is sold directly increases export revenue recorded there. Although the resulting rise in domestic incomes may also raise spending on imports to some extent, the direct effect of higher export earnings works in the opposite direction to this. Provided the increase in import spending does not fully offset the higher export revenue, Nordavia’s current account balance improves. In clear contrast to a situation where growth is driven mainly by rising domestic incomes and consumption, which tends to pull in more imports and worsen the current account instead.

Final answers

(a) Unemployment falls, as higher export incomes raise labour demand directly and, via the multiplier, throughout the economy
(b) Inflation rises, as higher aggregate demand creates demand-pull pressure, especially near full capacity
(c) The current account improves, since higher export revenue is a direct credit item, provided import spending does not rise by as much or more