Balance of Payments

Question 1

What is the balance of payments?

Answer 1

The BOP records all financial transactions between consumers, firms, and the gvt in one country with other nations.

Movements of G/S are offset by movements of money. The BOP balances.

Question 2

What is the Capital Account?

Answer 2

It records flows of international capital transfers, measured by funds from investments and loans.

Question 3

What is the Financial Account?

Answer 3

Flows of money from investment, savings, speculation, and currency stabilization. (where FDI goes)

Question 4

State the 4 components of the current account.

Answer 4

Trade in goods, trade in services, primary income, secondary income.

Question 5

How are trade in G/S calculated in the current account and give examples.

Answer 5

Exports minus Imports

Goods - raw materials, tech, components
Services - Insurance, tourism, research

Question 6

What is primary income and give examples.

Answer 6

Income from assets owned abroad minus income payed out on UK assets owned by foreigners.

E.g. profits, interest from foreign investments.

Question 7

What is secondary income and give examples.

Answer 7

Government transfers to and from overseas organizations (like the EU).

E.g. overseas aid, debt relief.

Question 8

What is a trade deficit and a trade surplus?

Answer 8

Trade deficit - Outflows > Inflows

Trade surplus - Outflows < Inflows

Question 9

What are the 5 structural causes of a current account deficit?

Answer 9

Under-Investment (low-quality G/S, no demand abroad)

Low Productivity (high CoP, high £, cheap elsewhere)

High Inflation (expensive exports, not competitive)

Low R&D, low innovation

More low-cost competition

Question 10

What are the 5 cyclical causes of a current account deficit?

Answer 10

Overvalued exchange rate (exports dearer)

Boom in domestic demand (more D for imported raw materials, G/S sold domestically instead of exported)

Recession in key export markets (exports cheap elsewhere)

Global export prices fall (less D for UK exports)

Increased demand from exported technology

Question 11

What are the 2 benefits of a trade deficit?

Answer 11

Imported capital goods improve productive capacity, can increase GDP growth.

High imports mean more G/S for consumers in the short term.

Question 12

How does the balance of payments affect AD?

Answer 12

Deficit reduces AD - high imports, low exports

Surplus increases AD - low imports, high exports

Question 13

What is the balance of payments crisis?

Answer 13

When a country can’t afford to pay for essential imports or pay interest on its debts.

Question 14

What are the 3 drawbacks of a trade deficit?

Answer 14

Lower AD and lower growth

Domestic job loss (uncompetitive exports, AD falls)

Currency weakness/ inflation (high imports leads to depreciation, increases AD and exports, inflation)

Question 15

What is a trade gap?

Answer 15

The amount of money where imports > exports (current account)

A trade deficit occurs in all parts of the BOP. CA deficit means there is a FA surplus.

Question 16

What are the 5 causes of a trade surplus?

Answer 16

Export-led growth

Undervalued exchange rate (cheap exports, more competitive, High D)

High domestic savings rates (consumers save rather than spend)

Closed economy (low M due to protectionism)

Investment from overseas income

Question 17

What are the 5 drawbacks of a trade surplus?

Answer 17

Too much saving, not enough spending

Lack of domestic investment

Wage restraints (to keep CoP low) low wages reduce domestic consumption and imports.

The surplus has to be offset elsewhere (other countries get deficits when they buy your goods)

Low gvt spending (poor infrastructure), low investment reduces competitiveness.