4.1.7 Balance Of Payments

Question 1

What are the 3 components of the BoP?

Answer 1

• The Current Account
• The Financial Account
• The Capital Account

Question 2

What is the Current Account?

Answer 2

Trade in goods and services and income / current transfers.

This includes all economic transactions between countries.

Question 3

What is the financial account?

Answer 3

FDI, portfolio investment and other investments.

Question 4

What is the capital account?

Answer 4

The capital account is relatively unimportant as it mainly records transfers of immigrants and emigrants taking money abroad or bringing to the UK, or government transfers such as debt forgiveness to Third World countries.

Question 5

What does the balance of payments show overall?

Answer 5

The balance of payments shows all flows into and out of the country and since total inflows must equal total outflows, the balance of payments must balance.

Question 6

What are the short term causes of a deficit and surplus in the BoP

Answer 6

Changes in consumer demand -> if demand rises quicker than the Supply side of economy can deliver, the excess demand is met by importing.

Strong exchange rate -> reduces UK price of imports.

Inflation will decrease exportssince it will increase the price of UK goods compared to goods abroad.

Question 7

Explain the income elasticity with regards to the BoP?

Answer 7

UK consumers have a high - income elasticity of demand for imports so the deficit tends to grow when the economy enjoys a period of consumption led growth.

Question 8

What are the medium term causes of a deficit and surplus in the BoP

Answer 8

If a country loses its compartive advantge - people will transfer their purchases to other countries and the UK will need to switch resources to production of other things.

Question 9

What are the long term causes of a deficit or surplus in the BoP

Answer 9

Lack of Capital investment

Deindustrialisation

Countries with large amounts of natural resources export more

Corruption / political position / reputation

Question 10

What are the 3 ways to fix a deficit in the CA?

Answer 10

Demand side policies - Monetary / Fiscal policy - reduce AD - reduce income - high income elascitity for imports so should work.

Supply side policies - improve the productivity, quality and efficiency of domestic brands to make them more competitive.

Expenditure switching policies - Tariffs or quotas. Devaluating the pound (make exports cheaper through dropping IR so less demand for £) - subject to J curve.