4.1.7 - Balance of Payments

Question 1

Causes of Current Account Deficit

Revenue is used when referring to exports

Expenditure is used when referring to imports

Answer 1

1. ) Strong domestic growth — if real disposable incomes increase due to a boom for example, the marginal propensity to consume will increase, which increases the marginal propensity to import. This will increase demand and this expenditure of imports, resulting in current account deficit, assuming ceteris paribus. This worsens the trade balance of the current account
2. ) Recession abroad - If the real disposable incomes fall abroad in the economies due to a recession for example, the demand for domestic exports will decrease, leading to a fall in the revenue from exports, due to less domestic consumption. This worsens the trade balance of the current account causing a current account deficit
3. ) A strong exchange rate makes exports dearer and imports cheaper. This means that demand for imports and therefore expenditure on imports will rise, whilst the demand for exports decrease, as well as the revenue from exports decrease. Both effects worsen the trade balance of the current account, hence causing a current account deficit
4. ) Low labour productivity means output per hour worked is low relative to competitor countries around the world. This increases unit labour costs, a major cost of production for firms, who will reflect this through higher prices, reducing the price competitiveness of a country’s exports. This reduces demand and thus reduced revenue from exports, worsening the trade balance of the current account, resulting in a current account deficit

Question 2

Causes of Current current account surplus

Answer 2

. The causes of current account surplus are mostly the opposite for causes of current account deficit:

. Weak Exchange Rate

. Boom abroad (higher incomes abroad)

. Low domestic growth (low disposable income)

. High labour productivity, relative to competitor countries around the world

Question 3

Why is current account deficit detrimental to the economy?

Answer 3

1.) If a current account is deficit is financed through borrowing is it said to be unsustainable. This is because borrowing in unsustainable in the long run and countries will be burdened with high - interest payments. This means countries with large interest payments will have little to spend on investment, in the long run.

For example, Sri Lanka took out huge loans with high interest payments in the 2010s. This led to a current account deficit as the value of imported goods and services was greater than the value of exported goods and services. In other words, there was more consumption from

However, the large interest payments meant that the level of investment from the government in the long run decreased. Eventually there was inflation due to demand pull inflation due to a lack of supply, after the level of investment decreased by the government

Question 4

Consequences of Current Account Deficit

Answer 4

1. ) Unemployment increases, since labour is a derived demand, derived from the demand goods and services. As ds demand goods and services is low, firms require fewer workers to produce, thus increasing unemployment. Furthermore, as AD is low (low consumption), revenue for firms will flowing, meaning firms will lay of workers (made
   redundant) , increasing unemployment, in order to reduce the cost of production and remain profitable

2.) Demand pull inflation increases.

Question 5

Consequences of a Current Account surplus

Answer 5

1. ) Unemployment decreases. This is because labour is a derived demand, derived from the demand to produce goods and services. As the demand goods and services is high, firms will need more workers to produce extra output, thus reducing unemployment
2. ) However, demand pull inflation increases, from P1 to P2, since AD shifts from AD1 to AD2. This is due to more pressure on existing factors of production, increasing the price of them. The level of AD will be higher than AS, increasing prices of goods ands services