4.1.7: Balance of Payments Flashcards
What are the short term causes of deficits and surpluses in the balance of payments?
- High levels of consumer demand
- High income elasticity of demand for imports
- Strong exchange rate
- A high level of relative inflation
What are the components of the balance of payments?
- The current account
- The capital and financial accounts
What are the medium and long term causes for deficits and surpluses in the balance of payments?
- Medium: Comparative advantage
- Long: A lack of capital investment
- Deindustrialization
- Natural resources
- Competitiveness
- Corruption
How do high levels of consumer demand cause a deficit in the balance of payments?
- If real household spending/ demand grows quicker than the aggregate supply side, the way the economy can meet this demand is by importing those goods and services, causing a higher level of imported goods, potentially leading the country to a deficit.
- High incomes in a country lead to high imports but have no effect on the level of exports.
How does the income elasticity of demand for imports cause surpluses/ deficits in BoP?
- The UK has high income elasticity of demand for imports so the deficit tends to grow when the economy is in a period of consumption led growth.
How does the income elasticity of demand for imports cause surpluses/ deficits in BoP?
- The UK has high income elasticity of demand for imports so the deficit tends to grow when the economy is in a period of consumption led growth.
How do exchange rates cause surpluses/ deficits in BoP?
- A strong exchange rate leads to exports being more expensive, and imports cheaper which can cause a deficit as there will be lower demand for that country’s exports and there will be higher aggregate demand for imports. (Eg UK, where we import more goods.
- A weaker exchange rate can lead to a BoP surplus, as imports will be more expensive and exports will be cheaper, meaning the demand from other countries for that country’s exports will be increased.
- ## Eg China, which has a floating exchange rate and weaker currency, which causes them to be in a trade surplus and BoP surplus.
How do exchange rates cause surpluses/ deficits in BoP?
- A strong exchange rate leads to exports being more expensive, and imports cheaper which can cause a deficit as there will be lower demand for that country’s exports and there will be higher aggregate demand for imports. (Eg UK, where we import more goods.
- A weaker exchange rate can lead to a BoP surplus, as imports will be more expensive and exports will be cheaper, meaning the demand from other countries for that country’s exports will be increased.
- ## Eg China, which has a floating exchange rate and weaker currency, which causes them to be in a trade surplus and BoP surplus.
How does comparative advantage affect BoP surplus/ deficit?
- When a country loses its comparative advantage, people will transfer their purchases to other countries and the UK will need to switch resources to production of things. Eg from the manufacturing sector to the tertiary sector (services)
How does a lack of capital investment affect BoP deficit?
- Causes firms to use older and more out of date technology, which contributes to lack of productivity, causing a trade deficit and in turn BoP deficit.
What are the two short term ways in reducing BoP imbalance?
- Demand side polices (Monetary and Fiscal)
- Supply Side policies (Improving Efficiency, productivity and quality
What are some expenditure switching policies that are long term solutions to imbalance?
- Tariffs or Quotas: reduce the attractiveness of imports. EV: could cause trade wars as in retaliation counties could place protectionist policies also e.g. China & Usa
- Attempting to control inflation
- Devalue/ Depreciating the currency as it makes exports cheaper and imports more expensive. EV: it doesn’t always work for many countries as they have a floating exchange
