2.1.4 Balance of Payments (Edexcel)

Question 1

What are the balance of payments?

Answer 1

The balance of payments (BoP) is a record of all economic transactions between a country and the rest of the world. It is divided into three main accounts: the current, capital and financial account.

Question 1

What does the current account include?

Answer 1

1. Balance of trade in goods
2. Balance of trade in services
3. Income balance
4. Current transfers

Question 2

What does the Balance of Trade in Goods measure?

Answer 2

• It measures the difference between the value of a country’s exports and imports of tangible goods (e.g., machinery, cars, and clothing). A trade surplus occurs when exports exceed imports, and a trade deficit occurs when imports exceed exports. Example: China consistently runs a trade surplus due to its strong manufacturing sector, exporting products worldwide.

Question 3

What does the Balance of Trade in Services measure?

Answer 3

• It accounts for the value of services traded internationally, such as tourism, financial services, and consulting. A surplus occurs when a country exports more services than it imports. Example: The United States often has a surplus in services trade due to its leadership in technology and financial services.

Question 4

What does the Income Balance measure?

Answer 4

This includes earnings from abroad (e.g., dividends, interest, and wages) and payments made to foreign investors. A surplus indicates that a country earns more from its foreign investments than it pays to foreign investors.

Question 5

What do Current Transfers measure?

Answer 5

This category includes foreign aid, remittances sent by migrant workers, and other unilateral transfers. It can be positive (inflows) or negative (outflows).

Question 6

What happens in a current account deficit and give me an example?

Answer 6

A Current Account Deficit occurs when a country’s imports of goods, services, income, and transfers exceed its exports in those categories. It implies that the country is spending more than it is earning from the rest of the world.
Example: The United States has often had a current account deficit, as it imports more goods and services than it exports. The UK is also in one.

Question 7

What happens in a current account surplus and give me an example?

Answer 7

• A Current Account Surplus occurs when a country’s exports of goods, services, income, and transfers exceed its imports. It implies that the country is earning more than it is spending internationally.
• Example: Germany has frequently had a current account surplus due to its strong export-oriented economy.

Question 8

What is the Impact of Current Account imbalances on exchange rates?

Answer 8

A persistent current account deficit may lead to a depreciation of the country’s currency, making exports more competitive and imports more expensive. This can help correct the deficit.

Question 9

What is the Impact of Current Account imbalances on economic growth?

Answer 9

A surplus can lead to higher savings and investment, potentially boosting economic growth. However, a persistent deficit may lead to unsustainable borrowing.

Question 10

What is the Impact of Current Account imbalances on employment?

Answer 10

A trade surplus may support job creation in export-oriented industries, while a deficit can lead to job losses in import-competing sectors.

Question 11

What is the Impact of Current Account imbalances on inflation?

Answer 11

A depreciating currency (due to a deficit) can lead to imported inflation, affecting the domestic price level.

Question 12

Explain the interconnectedness of economies through international trade and an example of this.

Answer 12

• International trade fosters economic interdependence among countries. One country’s economic policies and developments can have ripple effects globally.
• Example: The 2008 financial crisis in the United States had global repercussions, as it led to reduced demand for imports from other countries, affecting their economic growth.

Question 13

Explain supply chain integration and an example.

Answer 13

• Supply chain integration: Many products involve components from multiple countries. Disruptions in one country can disrupt global supply chains.
• Example: The COVID-19 pandemic disrupted supply chains worldwide, affecting industries from electronics to pharmaceuticals.

Question 14

Explain benefits of international trade and an example.

Answer 14

International trade allows countries to specialize in producing what they are most efficient at, leading to efficiency gains and a higher standard of living.
Example: Switzerland specializes in the production of high-quality watches, benefiting from a strong reputation in the global market.

Question 15

What does the current account measure?

Answer 15

The current account measures the difference between money and credit going in and out of an economy (through
exports, imports and income paid on assets both home and abroad).

Question 16

Does a current account deficit matter? If so, then what does it cause?

Answer 16

1. Loss of aggregate demand which then causes a slower rate of real GDP growth and thereby reduced living
   standards
2. Loss of jobs in home-based industries, which may contribute to regional decline and structural unemployment
   problems
3. Can lead to currency weakness (due to less demand for the currency) and higher inflation, and so a country
   may run short of vital foreign currency reserves
4. Trade deficit might actually be a reflection/symptom of a lack of competitiveness / supply-side weaknesses

Question 17

What are some of the causes of a current account deficit?

Answer 17

• Poor price and non-price competitiveness
• Strong exchange rate affecting exports and imports
• Recession in one or more major trade partner countries
• Volatile global prices (e.g. Commodities)
• Booming domestic economy

Question 18

Explain how poor price and non price competitiveness is a cause of a deficit.

Answer 18

• Higher relative inflation than a nation’s trading partners
• Low levels of capital investment and research and development spending
• Weaknesses in design, branding, performance and low labour productivity

Question 19

Explain how a stronger exchange rate affecting exports and imports is a cause of a deficit.

Answer 19

• High currency value increases the prices of exports perhaps causing falling sales
• Appreciating currency also makes imports cheaper, a substitute for home output

Question 20

Explain how a recession in one or more major trade partner countries is a cause of a deficit.

Answer 20

• Recession cuts the value of exported goods and services to these countries
• Businesses may find barriers to switching towards markets of faster-growth nations

Question 21

Explain how volatile global prices is a cause of a deficit.

Answer 21

• Exporters of primary commodities might be hit by a fall in global prices
• Commodity-importing nations could be hit by higher world prices for oil and gas

Question 22

Explain how a booming domestic economy is a cause of a deficit.

Answer 22

• Domestic producers need to import more raw materials from abroad
• Households, especially with a high propensity to import, buying more imports due to having more income

Question 23

What are the key features of global trade patterns?

Answer 23

• Around a quarter of all output produced globally is exported
• Production chains are becoming more complex i.e. a final good might have been made in many stages across
  many countries; around 30% of global exports have been made from imported goods/services
• Bilateral trade is becoming increasingly more important i.e. if country A exports to country B then B is also
  likely to export to country A – trade is rarely “unilateral” (in one direction)
• Until the 1970s, a significant proportion of trade was between rich countries, but there is now much more
  trade between rich and poor countries, and between poor countries
• China, the US, Germany, France and Japan account for just under 40% of all international trade
• China remains the economy with the largest value of trade, but its share is falling – it is currently around 11%