balance of payments

Question 1

what is the balance of payments

Answer 1

This is a record of all financial transactions made between consumers, firms and the government from one country with other countries

It states how much is spent on imports as well as what the value of the export is

Question 2

what are exports

Answer 2

goods and services bought from foreign countries – they are positive in the balance of payments – because they are an inflow of money

Question 3

what are imports

Answer 3

are goods and services bought from foreign countries – they are negative on the balance of payments – they are an outflow of money

Question 4

what’s the balance of payments made of

Answer 4

the current account

the capital account and the financial account

balancing item

Question 5

what is the current account

Answer 5

this includes all economic transactions between countries – the main transactions are the trade in goods and services, income and current transfers

Question 6

what is the capital account and financial account

Answer 6

capital transfers involve transfers of the ownership of fixed assets – the financial account involves investment – such as direct investment, portfolio investment and reserve assets being part of their financial account

Question 7

what is the balancing item

Answer 7

the components of the balance of payments should balance – the sum of the accounts should be zero – where there are imbalances a balancing item is used to cover discrepancies

Question 8

what is a current account surplus

Answer 8

• A current account surplus means there is a net inflow of money into the circular flow of income – the UK has a surplus with services – but a deficit with goods

Question 9

what is a current account deficit

Answer 9

The UK has a net current account deficit – means the UK spends more on imports from foreign countries than they earn from exports to foreign countries – if the deficit is large and runs for a long time, there could be financial difficulties with financing the deficit

Question 10

causes of balance of payments disequilibrium (6)

Answer 10

appreciation of the currency

economic growth

more competition

deindustrialization

membership of a trade union

attractiveness to foreign investors

Question 11

how can the appreciation of currency cause disequilibrium

Answer 11

a stronger currency means imports are cheaper but exports are more expensive – meaning the current account deficit would worsen

Question 12

how can deindustrialization cause disequilibrium BOP

Answer 12

In the UK manufacturing sector has been declining since the 1970s – goods that the UK previously made domestically now have to be imported – worsens the deficit

Question 13

how can increased competitiveness cause a disequilibrium of BOP

Answer 13

– if a country becomes more internationally competitive – such as with lower inflation or if there is economic growth in exporg markets – exports should increase – this also occurs when a country becomes more productive – since that causes the average cost to fall – this could cause the current account

Question 14

how can economic growth cause disequilibrium of BOP

Answer 14

when consumer incomes increase - demand increases – this could increase demand for imports – this is especially true of a country such as the UK where consumers have a high propensity to import

Question 15

how can being a member of a trade union cause disequilibrium of BOP

Answer 15

the UK has traditionally had negative current transfers – as fees are paid for membership of the EU

Question 16

how can the attractiveness to foreign investors causes disequilibrium of BOP

Answer 16

a capital account surplus could be caused by incoming finance from investors buying UK bonds, securities and financial derivatives – this could help fund a current account deficit

Question 17

what effects does a current account surplus have on financial and capital account

Answer 17

will cause a deficit on capital and financial account - vice versa

Question 18

what happens if the UK exports more to foreign countries

Answer 18

• By selling more exports to foreign countries – the UK will have a greater inflow of money into the circular flow of income – this will increase AD and improve the rate of economic growth

Question 19

how does economic growth effect the current account

Answer 19

• During periods of economic growth – when consumers have higher incomes – they can afford to consume more – larger deficit on the current account

Question 20

what is FDI

Answer 20

FDI is the flow of capital from one country to another – in order to gain a lasting interest in an enterprise in the foreign country

Question 21

benefit of FDI - unemployment

Answer 21

FDI can help create unemployment – encourages innovation of technology and help promote long term sustainable growth – provides LEDCs with funds to invest and develop

Question 22

how is fiscal policy used to correct balance of payments

using change level of income tax

Answer 22

• If there is a deficit on the current account – income tax could be increased – this will reduce the amount of disposable income consumers have – reduces quantity of imports – however – may impact domestic growth – since consumers will also spend less on domestic goods

Question 23

how is fiscal policy used to correct balance of payments

by changing gov spending

Answer 23

• Gov could also reduce their spending – reduces AD – leads to less imports – forces domestic firms into increasing exports – helps improve the disequilibrium

Question 24

is fiscal policy more effective in short or long term and why

Answer 24

• Fiscal policy is effective in the short term – not so much in the long term – as soon as policy ends – households likely to revert their expenditure back on imports

Question 25

expenditure reducing policies

Answer 25

Expenditure reducing policies aim to reduce demand in the economy – spending on imports fall

Question 26

expenditure switching policies

Answer 26

Expenditure switching policies aim to switch consumer spending towards domestic goods and away from imports

Question 27

the significance of of deficits and surplus for an individual economy (2)

Answer 27

• If imported raw materials are expensive – may be cost push inflation in the domestic economy – as firms face higher production costs
• International trade has meant countries have become interdependent – therefore economic conditions in one country affect another country – as quantity they import and export has changed