4.2 Balance of payments

Question 1

What is meant by a balance of payments?

Answer 1

The record of all financial transactions between one country and the rest of the world

Question 2

What is counted as a positive entry?

Answer 2

Inflows of income from overseas. E.g. exports sold overseas

Question 3

What is counted as a negative entry?

Answer 3

outflows of income to overseas. E.g. imports bought from overseas.

Question 4

what are the 4 main areas that make up the current account?

Answer 4

• trade in goods
• trade in services
• income flows
• transfers

Question 5

What is meant by the current acount?

Answer 5

it is part of the balance of payments and is the record of trade in goods and services, income flows and transfers between one country and the rest of the world

Question 6

What is meant by trade in goods?

Answer 6

Shows the balance of earnings from exports and spending on imports of goods

Question 7

What is meant by trade in services?

Answer 7

shows the balance of earnings from exporting services and the spending on imports of services

Question 8

What is meant by income flow?

Answer 8

the earnings on investments abroad, e.g. interest that foreigners earn in the UK, and that UK nationals earn on investments abroad

Question 9

What is meant by transfers?

Answer 9

Transfers are the movement of money or goods and services without any requirements of payment. e.g. foreign aid or money sent ‘home’

Question 10

What is the balance of payments of the current account?

Answer 10

the total net trade in goods and services, income flows, and transfers between one country and the rest of the world

Question 11

How do you calculate the balance of payments on the current account?

Answer 11

You do so by adding together all the items under trade in goods, trade in services, income flows and transfers

Question 12

What does a balanced current account mean?

Answer 12

a balanced current account means that a country’s revenue from overseas is the same as its spending overseas

Question 13

Is a balanced current account likely to happen and is it necessary?

Answer 13

A balanced current account is unlikely and unnecessary since other sections in the balance of payments automatically cancel any surplus or deficit

Question 14

What does a current account surplus mean?

Answer 14

It is where the sum of exports plus the inflow of income and transfers is greater than the sum of imports and the outflow of incomes and transfers. In other words, the countries revenue from overseas is greater than its spending overseas

Question 15

What does a current account deficit mean?

Answer 15

it is where the imports plus the outflow of income and transfers are greater than the sum of exports and inflow of income and transfers

Question 16

What are 3 factors that economists examine when weighing up the importance of the balance of payments on current account?

Answer 16

• whether there is a deficit or a surplus
• the size and duration of the deficit or surplus
• the effects of the current account balances within the balance of payments

Question 17

When is a current account deficit of a particular importance and concern?

Answer 17

• if it is caused by problems in the economy, such as falling total demand for domestic goods, which can be linked to increased unemployment, less income tax revenue and higher benefit payments for the government
• if it is due to a factor that will take a long time to change, such as low productivity, then the deficit will last longer which makes it harder for the country to be able to finance
• if it is large in size, then it will be harder for the country to be able to finance and it can lead to a larger increase in national debt

Question 18

When is a current account deficit not so important or of a concern?

Answer 18

• if it is only temporary, e.g. due to importing raw materials or capital goods to put into the production of goods that will eventually be exported and increase economic growth
• if it reduces inflation within the domestic economy: imports are greater than exports, thereby decreasing demand and reducing the upwards pressure on on prices
• if over time it leads to a fall in the exchange rate, which can increase the international competitiveness of UK goods and eventually increase exports
• if it is only a small % of GDP so the debt can be paid for by the country with less difficulty

Question 19

When is a current account surplus of importance and benefit?

Answer 19

• if it reflects the rising total demand for domestic goods, which can be linked to decreased unemployment, more income tax revenue and less benefit payments for the gov
• if it decreases the debt of a country because more money is flowing into the country from greater exports than money flowing out of the country to pay for imports

Question 20

When is a current account surplus of no importance or benefit?

Answer 20

• if it causes rising inflation within the domestic economy: as exports are greater than imports, thereby increasing total demand for domestic products and putting upwards pressure on prices
• if it hides the causes that have a negative impact on global economic growth such as protectionist policies that give domestic goods an artificial advantage
• if it leads to a rise in the exchange rate, which can decrease the international competitiveness of UK goods and eventually decrease exports

Question 21

What are the causes of surpluses on the balance of payments on current account?

Answer 21

• the strength of the economy, e.g. products are of a high quality, sold at a low price and reflect what households and firms at homes and overseas want to buy
• A lack of growth in the domestic economy: consumers in the economy may buy fewer imports, while domestic firms, finding it difficult to sell at home, compete more to sell exports abroad
• a fall in the exchange rate, which may increase the quantity of exports sold if consumers overseas react to the now lower export prices, and it may similarly reduce imports
• a net inflow of investment incomes: investments that foreign residents have made in the country earn less than the investments the countries inhabitants have made in other countries

Question 22

What are the causes of deficits on the balance of payments on current account?

Answer 22

• structural problems in the economy, e.g. firms overpricing goods, producing poor-quality goods or goods no longer in demand
• falling incomes overseas, which may lead to falling exports. Also rising incomes in the domestic economy may in turn lead to rising imports
• a rise in the exchange rate, which may decrease the quantity of exports overseas if consumers overseas are responsive to the now higher prices of exporting, and similarly may increase the quantity of imports
• a net flow of investments income: the investments that foreign residents have made in the country earn more than the investments the countries inhabitants have made in other countries