Cambridge International as and a level Economics Ebook

Supply side policy
Supply side policy measures may reduce a current 
account defi cit and a fi nancial account defi cit by making 
domestic products more price competitive and by making 
domestic markets more attractive to invest in. For 
instance, deregulation and privatisation may increase 
SELF-ASSESSMENT TASK 
5.4
The Egyptian Central Bank takes action
Egypt’s current account deficit rose significantly in 
2013. This contributed to a fall in the country’s off icial 
reserves and led to a reduction in the value of the 
Egyptian pound (£E). The depreciation was, in eff ect, 
equivalent to a wage cut and reduced living standards, 
at least in the short run.
Concerns over the growing current account deficit and 
falling reserves led the central bank to increase its 
exchange controls. Some economists expressed concern 
that the exchange controls would discourage foreign 
direct investment.
Read the feature below and then answer the questions that follow.
1
Why may a current account defi cit cause a country’s 
reserves to fall?
2
Explain why a depreciation is ‘equivalent to a wage 
cut’ in the short run.
3
Analyse why exchange controls may discourage 
foreign direct investment.
121
Chapter 5: Government macro intervention 

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the competitive pressure on domestic fi rms to keep costs 
and prices low, to improve quality and to become more 
responsive to changes in consumer demand.
Increased spending on education and training and 
increased investment may also increase exports and 
encourage foreign direct investment. A more skilled 
labour force and better capital equipment may reduce 
the relative price of domestic output and raise its 
quality. Both of these eff ects will be likely to increase 
domestic fi rms’ share of the home market and the 
global market.
A skilful labour force and good quality capital 
equipment may also attract foreign multinational 
companies to set up branches in the country in 
expectation they will be able to produce good quality 
products at low cost. Portfolio investment may also 
increase as the country’s economic prospects are likely to 
improve as a result of higher aggregate supply.
Trade union reform may enable domestic fi rms to work 
with more fl exibility and so be more responsive to changes 
in demand. A resulting fall in industrial action may, in 
addition, make multinational companies more willing to 
invest in the country.