Balance Of Payments Flashcards
What are balance of payments
A record of a country’s transactions with the rest of the world
What is a current account surplus
Payment into a country is greater than the payments going out
What is a current account deficit
Payment out from a country is greater than the payments coming in
What are the 4 parts to the current account
Trade in goods, trade in services, net income flow, net current transfers
Examples of primary income
Wages/investment income
What is a debit (-)
Money leaving the UK
What is a credit (+)
Money coming into the UK from other countries
What are investment incomes
I come received on foreign direct investment
What is secondary income
Money for nothing. E.g. remittances
What are remittances
Transfer of money from a foreign worker to their family in a diff country
Impact of inward FDI on UK
Initially a big one off credit. Subsequently a continuous debit
What is the connection between a growing economy and trade deficits
After a recession trade deficit often quickly rises
How is spending on imports linked to the business cycle
In a book we buy more imports of things we want and in a recession labour costs may fall making UK good cheaper to produce
When can a current account deficit become a problem
Persistent deficit, when it forms a large share of GDP, no compensation inflows, low central bank reserves, country has a poor record of repaying debt
When do imbalances on the balance of payments occur
When the difference between imports and exports becomes higher than expected
What can cause imbalances
Structural or temporary factors. E.g. structural as we are good at services but can’t compete with low wage countries on mass produced goods. Temporary is caused by the economic cycle
What can cause a current account deficit
economic growth (higher spending on imports), exchange rate (SPICED), relative competitiveness of an economies exports (wages, productivity, infrastructure, investment)
define international trade
exchange of goods and services across international borders
define absolute advantage
a country can produce a good or service using fewer resources and at a lower cost than another country
define comparative advantage
occurs when a country can produce a good or service at a lower opportunity cost then another country
what are the benefits from trade
increase national income, increases consumer choice and stimulates innovation
why is stimulating innovation a good thing and define it
the process of translating an idea of invention into a good or service that creates value of for which customers will pay. Helps gain a competitive advantage
why is specialization good
more output is produced using the same amount of resources
why is comparative advantage important
output will be increased, specialization means higher volumes
how come comparative advantage can change over time
non-renewable resources run out, investment in research/development, exchange rates change, import controls e.g. tariffs.
what is a fixed exchange rate
pegged. central bank sets exchange rate, maintain exchange rate at target rate
what is a floating exchange rate
determined by the forces of supply and demand
what causes demand for currencies
exports, inflows of investment. speculative buying (hot-money), central bank buying up their own currencies
what effects the supply of a currency
demand for imports, outflows of investment, speculative selling, selling their own currency
advantage and disadvantages to fixed exchange rates
+ greater certainty + strong discipline on domestic firms. - fragile - inflexible so take away the natural stabilizer of exchange rates
advantages and disadvantages to floating exchange rate
+ provide an automatic adjustment + gives government/monetary authorities flexibility in determining interest rates. - uncertainty - lack of economic discipline (may be inflationary) - effect on FDI
What can devaluation cause
raise in AD, keep inflation down, exports may suffer and people may lose their jobs
what are the terms of trade
measure the price index of exports divided by the price index of imports
terms of trade formula
index of export prices / index of import prices x 100
consequences of improving terms of trade
for every unit of exports sold it can buy more units of imported goods, beneficial effect on cost-push inflation, improve standard if living. May cause fall in export volume
consequences of worsening terms of trade
every unit of exports sold it can buy fewer units of imported goods, damaging effect on cost-push inflation, reduce standard of living, increase export volumes
how important are the terms of trade
tells us how a country may benefit from international trade. Very important for some countries like if they are dependent on primary commodities e.g. Zambia with copper
what does international competitiveness measure
the relative cost and value of a countries exports
what short-term factors can increase international competitiveness
low inflation, weaker exchange rate
what long - term factors can increase international competitiveness
better education, healthcare, infrastructure. Improved national productivity, better quality of goods produced
with fixed exchange rates what effects competitiveness
micro factors e.g. cost of materials/labour
what can cause fluctuations in the price of primary commodities
occur on the supply-side dur to drought, floods, disease etc…
what is the marshall lerner condition
states that a currency devaluation will only lead to an improvement in the balance of payments if the sum of demand elasticity for imports and exports is greater than one
what does the J curve effect say
a trade deficit can actually worsen after a depreciation , but get better in the long-term
why are exports and imports slow to respond to changes in the exchange rate
short-term demand is inelastic. In the long-term demand becomes more elastic
