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Macro Econ 2 > Balance of Payments > Flashcards

Balance of Payments Flashcards

1
Q

What are the two main accounts in the Balance of Payments?

A

The two main accounts in the Balance of Payments are the Current Account and the Capital and Financial account.

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2
Q

What is the balance of payments?

A

The Balance of Payments is a record of payments (or transactions) between one country and the rest of the world.

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3
Q

Components of the Balance of Payments

A

The Balance of Payments is made up of the Current Account and the Financial & Capital Account.

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4
Q

Components of the Current Account

A

The components of the Current Account are: trade in goods, trade in services, investment income and current transfers.

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5
Q

Which of the following shows the impact on the UK Current Account of a UK consumer buying a product for £100 from America?

A

Imports are a withdrawal as they involve money leaving the circular flow of income to pay for goods and services abroad. Since money leaves the circular flow, this is recorded as a negative £100 on the current account.

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6
Q

Which of the following shows the impact on the UK Current Account of a UK bank selling £2400 of financial services to Germany?

A

Exports are an injection as they involve money from abroad entering the circular flow of income in exchange for British goods and services. Since money enters the circular flow, this is recorded as a positive on the current account.

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7
Q

What is the impact of an increase in imports on the UK Current Account?

A

Imports are a withdrawal from the circular flow because they involve money leaving the economy. As money leaves the circular flow, the UK Current Account will decrease.

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8
Q

A Spanish woman invests in a British business. How are the profits from this investment recorded in the UK Balance of Payments?

A

The profits are recorded in the investment income part of the Current Account. No goods or services are being imported or exported in this transaction - it is only profit that is moving abroad.
The investment income is leaving the UK. It will therefore be a negative on the UK Current Account, which will decrease as a result. The same investment income is entering Spain. It will therefore be a positive on the Spanish Current Account, which will increase.

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9
Q

Investment Income

A

A component of the Current Account which includes any rent or profit earned on an investment made abroad.

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10
Q

Current Transfers

A

When money is transferred abroad without getting any goods or services back in exchange.

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11
Q

Remittances

A

Money transferred back home from relatives working abroad.

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12
Q

Which of the following shows a current account deficit?

A

A negative current account where total inflows are less than total outflows

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13
Q

Which of the following will lead to a current account equilibrium?

A

There is a current account equilibrium when total inflows equal total outflows.

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14
Q

Current Account Deficit

A

When total outflows from the current account are greater than total inflows.

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15
Q

Current Account Surplus

A

When total inflows to the current account are greater than total outflows.

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16
Q

Current Account Equilibrium

A

When total outflows from the current account are equal to total inflows.

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17
Q

Trade Balance

A

Total value of exports minus total value of imports.

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18
Q

why the UK’s Balance of Payments balances?

A

In the UK, the Current Account is in deficit as more money is leaving the UK than is entering it. However, this means that the Capital & Financial Account must be in surplus as this money is reinvested back into the UK.

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19
Q

Warren Buffett is an American investor who buys shares in a British firm. How will the investment income for these shares appear in the UK Balance of Payments?

A

When Warren buys shares in the British company, this will be a positive in the British Capital & Financial Account as there is an inflow of money and a transfer of assets.

However, the income from these shares will appear in the Current Account as investment income is a component of the Current Account. It will be recorded as a negative in the current account as the investment income will leave the UK and go back to Warren Buffett in America.

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20
Q

What is FDI?

A

FDI stands for foreign direct investment. An FDI is an investment made by a firm in one country into a firm in another country in order to gain control over the foreign firm.

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21
Q

What is meant by Foreign Direct Investment and where is it recorded in the balance of payments?

A

FDI is recorded in the Capital & Financial Account and shows investments made by a firm to gain control over a foreign firm

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22
Q

Which of the following shows what is meant by a Current Account equilibrium?

A

Total inflows equal total outflows

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23
Q

Hot Money Flows

A

Money that investors move internationally between banks to maximise the interest they receive.

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24
Q

Spain’s inflation rate is 9% and Greece’s inflation rate is 2%. What is the impact of these different inflation rates on Spain’s Current Account?

A

Spain’s high inflation rate means that their exports are comparatively more expensive than Greek exports. Therefore, fewer foreign consumers will choose to buy Spanish exports. This means that demand for Spanish exports will fall and that Spain’s export revenue will decrease. This will worsen (decrease) their current account.

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25
Q

If a country experiences an appreciation of its exchange rate and an increase in relative inflation, what is likely to happen to the price of its exports?

A

An appreciation makes exports more expensive (SPICEE) and an increase in inflation relative to your trading partners will make your exports more expensive.

26
Q

If the UK fridge maker has higher costs than the German fridge maker, what is likely to happen?

A

An increase in costs will lead to higher prices and so exports will be less competitive. There will be a reduction in demand for the UK’s exports which will decrease export revenue and worsen (decrease) the UK’s current account.

27
Q

Exchange Rates

A

An appreciation of the exchange rate will decrease the current account.

28
Q

Relative Inflation Rates

A

High relative inflation rates will decrease the current account.

29
Q

Productivity

A

Low productivity will increase production costs and decrease the current account.

30
Q

As Saudi Arabia’s income increases, it will import

A

Inferior goods are those for which demand decreases as income increases. For normal goods, demand increases as income increases. So, as Saudi Arabia’s income increases, it will demand more normal goods and fewer inferior goods.

31
Q

Quality

A

A decrease in quality will decrease the current account.

32
Q

Growth

A

High economic growth will decrease the current account.

33
Q

Protectionism

A

The removal of protectionist measures will decrease the current account.

34
Q

What would a recession do to the current account?

A

Low economic growth such as during a recession should reduce demand for imported goods and so import expenditure will decrease. This will improve the Current Account.

35
Q

What does a balanced trade balance mean?

A

The trade balance is export revenue minus import expenditure. A balanced trade balance means that import expenditure is equal to export revenue.

36
Q

If a country moves from a balanced trade balance to a negative trade balance, what impact will it have on aggregate demand?

A

A negative trade balance means that import expenditure is greater than export revenue and so more money is leaving the economy than entering it. This means that AD is decreasing. In other words, if the trade balance decreases then the (X - M) part of the aggregate demand formula will decrease.This will in turn decrease AD overall.

37
Q

What is the impact of a severe depreciation of the pound on UK consumers?

A

A weak currency means that UK consumers must use a lot of pounds to purchase imports and so they become more expensive. This will decrease living standards as they can’t afford as much stuff.

38
Q

How does a worsening of the current account deficit affect aggregate demand?

A

A worsening current account deficit is usually caused by an increase in import expenditure and/or a decrease in export revenue. This will lead to a decrease in aggregate demand which will lead to a reduction in real GDP which in turn may cause lower living standards and higher unemployment.

39
Q

A severe depreciation of the pound can cause:

A

A depreciation of the pound causes an increase in the price of imports and a decrease in the price of exports. This causes an increase in demand for exports which will increase the demand for pounds. This will cause the pound to appreciate again.

40
Q

How is a worsening of the current account deficit most likely to affect aggregate demand and the exchange rate in the short run?

A

A worsening current account deficit is usually caused by an increase in import expenditure and/or a decrease in export revenue. This will lead to a decrease in aggregate demand which will lead to a reduction in real GDP which may cause lower living standards and higher unemployment.

An increase in imports means UK consumers must supply more pounds. A decrease in exports means that foreign consumers are demanding fewer pounds. This will cause the exchange rate to depreciate.

41
Q

An improvement of the Current Account deficit is caused by a decrease in imports and an increase in exports. How is this likely to affect the exchange rate?

A

A decrease in imports means domestic consumers must supply less of their currency. An increase in exports means that foreign consumers are demanding more pounds. This will cause the exchange rate to appreciate.

42
Q

How is a worsening of the current account deficit most likely to affect aggregate demand and the exchange rate in the short run?

A

A worsening current account deficit is usually caused by an increase in import expenditure and/or a decrease in export revenue. This will lead to a decrease in aggregate demand which will lead to a reduction in real GDP which may in turn cause lower living standards and higher unemployment.

An increase in imports means that UK consumers must supply more pounds. A decrease in exports means that foreign consumers are demanding fewer pounds. This will cause the exchange rate to depreciate as shown below.

43
Q

If a country moves from having a balanced trade balance to a positive trade balance, what will the impact be on aggregate demand?

A

A positive trade balance means that import expenditure is less than export revenue and so more money is entering the economy than leaving it. In other words, if the trade balance increases the (X - M) part of the aggregate demand formula increases resulting in an overall rise in AD.

44
Q

Which of the following is a possible impact of a severe depreciation of the US dollar?

A

A depreciation of the dollar causes an increase in the price of American imports and a decrease in the price of American exports. This causes an increase in the demand for American exports which will increase the demand for dollars. This will then cause the dollar to appreciate again.

45
Q

How is a worsening of the current account deficit most likely to affect aggregate demand and the exchange rate in the short run?

A

A worsening current account deficit is usually caused by an increase in import expenditure and/or a decrease in export revenue. This will lead to a decrease in aggregate demand which will lead to a reduction in real GDP which may cause lower living standards and higher unemployment.

An increase in imports means UK consumers must supply more pounds. A decrease in exports means that foreign consumers are demanding fewer pounds. This will cause the exchange rate to depreciate

46
Q

How will a reduction in import expenditure affect a country’s Current Account?

A

A reduction in import expenditure means that less money is flowing out of the economy and the Current Account will improve.

47
Q

How can a government reduce a current account deficit?

A

Using an increase in income tax or a decrease in benefits to reduce import expenditure by reducing overall expenditure.

48
Q

Trade barriers

A

Trade barriers are restrictions placed by a government on the imports of foreign goods.

49
Q

What happens to the quantity of washing machines supplied by domestic producers as a result of the introduction of tariffs?

A

The tariff will increase the price of imports meaning that domestic producers are able to charge a higher price (and don’t have to pay the tariff). This will incentivise them to supply more washing machines which will lead to an extension in supply. The supply curve does not shift as a result of a change in the price, instead we simply move up along it.

50
Q

Which of the following are types of transactions that appear in the Capital & Financial Account?

A

Foreign Direct Investment and hot money flows

51
Q

How will an increase in the UK interest rate affect hot money flows into the UK?

A

An increase in the UK interest rate will make saving in the UK more attractive to foreign investors and so more hot money will flow in.

52
Q

The two types of expenditure switching policy are

A

The two types of expenditure switching policy are trade barriers and interest rates.

53
Q

How does interest rates do up expenditure switching

A

Low interest rates both reduce the demand for a given currency (as fewer investors want to save in the country it belongs to) and increase the supply of the same currency (as more investors will sell it in order to save in other countries). This increase in supply and decrease in demand will depreciate the currency. A weaker currency makes imports more expensive. This means that consumers will demand fewer imports and switch to comparatively cheaper domestic goods.

54
Q

How is a decrease in the UK price level (relative to trading partners) likely to affect the UK’s net exports?

A

A decrease in the UK price level (relative to trading partners) will make British exports cheaper and should increase competitiveness. This will increase the demand for UK exports which in turn will increase export revenue. At the same time, domestic goods will be cheaper relative to imports. This this will incentivise consumers to switch to domestic goods which will lead to a decrease import expenditure.

55
Q

What impact does a rightward shift of the short run aggregate supply curve and/or the long run aggregate supply curve have on the price level?

A

A rightward shift of SRAS (decrease in cost of production) or LRAS (increase in quantity or productivity of factors of production) will decrease the price level as shown below.

56
Q

Expenditure Reducing Policies

A

Policies which aim to reduce expenditure on all goods in order to reduce import expenditure and improve the current account.

57
Q

Expenditure Switching Policies

A

Policies which aim to switch expenditure from imported goods to domestic goods. They include trade barriers and low interest rates.

58
Q

What does an increase in the interest rate do to Current Account

A

An increase in the interest rate will make saving in that country more attractive to foreign investors and so more hot money will flow in. Demand for that currency will increase and investors will supply less of that currency as they want to keep hold of it. This will cause an appreciation in the exchange rate.

A stronger pound makes imports cheaper. This means consumers will demand more imports and decrease demand for comparatively more expensive domestic goods. This will decrease the Current Account and therefore reduce the surplus.

59
Q

What is Hot Money?

A

Hot Money flows appear in the Capital & Financial Account. They occur when foreign investors move their money to foreign banks with the highest interest rate.

60
Q

The government decides to invest in infrastructure, education and apprenticeship schemes to aid the country’s manufacturing industry.

Which of the following shows a likely impact of this strategy?

A

Investing in infrastructure, education and apprenticeships should increase productivity and therefore reduce costs. An improvement in productivity and a reduction in costs will make exports from this country more attractive and cheaper, so foreign consumers will purchase more exports. Export revenue will therefore increase and the current account will improve.

61
Q

What effect does low economic growth during a recession have on the current account?

A

Low economic growth will reduce demand for imported goods and so import expenditure will decrease. This will improve the Current Account.

Macro Econ 2 (29 decks)

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