Chap 39

Question 1

Define balance of payments

Answer 1

A record of all economic transactions between the residents of a country and the rest of the world in a particular period (over a quarter of a year or more commonly over a year). These transactions are made by individuals, firms, and the government.

Money coming into the country is recorded as credit items and money leaving the country as debit items. The first section of the balance of payments, and the best known, is the current account.

Question 2

Define current account

Answer 2

Current account shows the income received by the country and the expenditure made by it in its dealings with other countries.

Question 3

Define Trade in goods

Answer 3

the value of exported goods and the value of imported goods

of goods including cars, food and machinery (merchandise/visible)

Question 4

Define Trade in goods deficit

Answer 4

expenditure on imported goods exceeding revenue from exported goods

Question 5

Define Trade in goods surplus

Answer 5

revenue from exported goods exceeding expenditure on imports.

Question 6

Define Trade in services

Answer 6

the value of exported services and the value of imported services

Question 7

Define Trade in service surplus

Answer 7

revenue from exported services exceeding expenditure on imported services.

Question 8

The components of the current account

Answer 8

1. Trade in goods
2. Trade in services
3. Primary Income
4. Secondary Income

Question 9

Define Primary income

Answer 9

income earned by people working in different countries and investment income which comes into
and goes out of the country

Question 10

Define Secondary income

Answer 10

transfers between residents and non- residents of money, goods or services, not in return for anything else.

includes charitable donations, workers’ remittances (money sent by migrant workers to relatives abroad and money received by relatives from migrant workers in other countries) and aid from one government to other governments.

Question 11

Categories of income flow (Primary income)

Answer 11

1. Compensation of employees
   includes wages, salaries and other benefits earned by residents working abroad minus that earned by foreigners working in the home economy
2. Investment income
   covers profit, dividends and interest receipts from abroad minus profit, dividends and interest paid abroad.

earned on foreign direct investment and financial investment including shares, government bonds and loans.

Question 12

Define current account surplus

Answer 12

When the value of credit items (Money coming into the country) exceeds the value of debit items (money leaving the country).

Question 13

Factors that influence the value of a country’s exports and imports

Answer 13

1. The country’s inflation rate.
2. The country’s exchange rate
3. Productivity (lower labour costs per unit– so exports should rise and imports fall)
4. Quality
5. Marketing
6. Domestic GDP (rise in income=more imports)
7. Foreign GDP (more income= more exports)
8. Trade restrictions

Question 14

How does a country’s inflation rate influence the value of a country’s exports and imports

Answer 14

High rate of inflation=
More imports
Difficulty in exporting

A fall in inflation=
^ a country’s international competitiveness
Increase exports
Reduce imports

Question 15

How does a country’s exchange rate influence the value of a country’s exports and imports

Answer 15

A fall in a country’s exchange rate will lower export prices and raise import prices. This will be likely to increase the value of its exports and lower the amount spent on imports.

Question 16

Causes of a current account deficit

Answer 16

1. Incomes at home and abroad
2. A high exchange rate (high export prices and low import prices)
3. Structural problems
4. Deficit on primary income and/or secondary income.

Question 17

Define cyclical deficit

Answer 17

A deficit arising from low incomes abroad and/or high incomes at home

Question 18

Structural problems that cause a current account deficit

Answer 18

Structural deficit

Problem with the products manufactured by firms in the country

Costs incurred to produce them

Prices at which they are sold

Strategies adopted for marketing them

Question 19

Consequences of a current account deficit

Answer 19

1. A deficit that has been caused by the import of raw materials and capital goods, changes in income is self-correcting
2. A deficit will put downward pressure on the exchange rate. If it does fall, exports will become cheaper and imports will become more expensive – as a result a deficit may be eliminated.
3. A deficit that’s the result of more primary and secondary income leaving the country than entering it may reflect a booming economy, with foreign MNCs making high profits in the country and sending the profits back to their economies and migrant workers earning high wages and sending some of them home to their relatives.
4. If firms’ costs of production are higher due to lower productivity or the quality of the products produced are poor or the products made are not in high world demand, the deficit may persist. In this case, government may have
   to introduce policies, particularly supply-side policies, to improve the country’s trade performance.

Question 20

What is a current account deficit

Answer 20

A country is consuming more goods and services than what it is producing

A reduction in inflationary pressure, as there will be a fall in aggregate demand.

Output and employment is lower than possible

Question 21

Significance of a current account deficit depends on

Answer 21

its size, duration and cause

Question 22

Causes of a current account surplus

Answer 22

1. A low exchange rate (This will make export prices cheap and import prices expensive)
2. High quality of domestically produced products.
3. High incomes abroad (more exports)
4. Low costs of production (makes products internationally competitive)
5. High investment income earned abroad
6. The receipt of high workers’ remittances (sending more money home)

Question 23

Consequences of a current account surplus

Answer 23

1. Increases an economy’s aggregate demand (demand-pull inflation)
2. Rise in real GDP
3. Higher employment
4. Appreciation in the exchange rate (demand for the economy’s currency will exceed its supply)

Question 24

Measures to correct a current account deficit

Answer 24

1. Imposing import restrictions
2. Subsidising exports
3. Reducing the country’s foreign exchange rate
4. Increasing income tax
5. Raising the rate of interest
6. Pushing up rates of indirect taxes

Long-term solutions-

1. Supply-side policy measures (education and training may result in lower average costs of production and a rise in the quality of products produced)

Question 25

Measures to correct a current account surplus

Answer 25

1. Revalue a fixed exchange rate
2. Encourage an appreciation of a floating exchange rate
3. Enable households and firms to purchase more imports by making use
   of expansionary fiscal policy and monetary policy