Handout 1: National Income Accounting in Open Economy: The Balance of Payments

Question 1

Unemployment

Answer 1

the problem of ensuring full employment in economies open to international trade

Question 2

Saving

Answer 2

a country’s saving or borrowing behaviour affects domestic employment and future levels of national wealth (savings are equal to investment in a closed economy, but can be different in an open economy).

Question 3

Trade imbalances

Answer 3

(the value of exports differs from the value of imports): They redistribute wealth among countries

Question 4

Money and the Price Level

Answer 4

The supply or demand for money affect both output and employment

Question 5

National Income Accounting

Answer 5

it records all expenditures that contribute to a country’s income and output

Question 6

GNP ( word definition)

Answer 6

the value of all FINAL goods and services produced by the factors of production of a country in a given time period. It is calculated by adding up the market value of all expenditures on final output. ( in what follows, GNP is identified with national income).

Question 7

GDP

Answer 7

the value of final goods and services produced within a country’s borders.

Example: A Spanish firm in the UK: Spain’s GNP but UK’s GDP

Question 8

GNP ( Equation definition)

Answer 8

GDP + net receipts of factor income from the rest of the world

Question 9

Expenditure View

Answer 9

divides GNP among its four possible uses:

1) . Consumption
2) . Investment
3) . Government purchases
4) . Current Account Balance CA

Question 10

Consumption C

Answer 10

The amount consumed by private domestic residents

Question 11

Investment I

Answer 11

The amount put aside by firms to build new plants and equipment

Question 12

Government Purchases G

Answer 12

The amount used by the government

Question 13

Current Account Balance CA

Answer 13

X-M : the amount of net exports of goods and services to foreigners

Question 14

Closed Economy

Answer 14

Y = C + I + G
so all output produced is consumed or invested ( or added to inventories) by the country’s citizens or purchased by its government.

Question 15

Open Economy

Answer 15

Y= C + I + G + (X - M)

• X is the value of goods and services exported ( sold to the rest of the world)
• M is the value of goods and services imported ( purchased from the rest of the world)

Question 16

The Current Account

Answer 16

It represents the value of exports minus the value of imports:
CA = X - M

Question 17

Current Account Surplus

Answer 17

If CA > 0 ( X>M): The country lends to the rest of the world ( accumulates foreign credit)

Question 18

Current Account Deficit

Answer 18

If CA < 0 (X < M): the country is borrowing from the rest of the world ( accumulates foreign debt)

Question 19

National Saving S

Answer 19

The proportion of output that is not devoted to private C or public consumption G
S = Y - C - G

Question 20

How can a closed economy save?

Answer 20

A closed economy can only save by building its capital stock:

Y= C + I + G => S=I

Question 21

How can an open economy save?

Answer 21

A open economy can save by building up its capital stock or by acquiring foreign wealth:

Y= C + I + G + CA => S= I + CA

Question 22

In what type of economy is it possible to increase investment without increasing savings?

Answer 22

In a open economy

Question 23

What is a open economy’s current account surplus often referred to as?

Answer 23

Net Foreign Investment because a country’s savings can be borrowed by a second country to increase its stock of capital

Question 24

Private Saving

Answer 24

The part of disposable income saved rather than consumed.

Sp = Y - T - C

Question 25

Government Saving

Answer 25

T is the net tax revenue

Sg = T - G

Question 26

National Savings

Answer 26

S*p* + S*g* 
S =*p* + S*g* = Y -T - C + T -G 
   = Y - C -G
   = I + CA
It can be shown that:
S*p* = I + CA + (G-T)
S*p* = I + CA - S*g*

Question 27

Balance of Payments Accounting

Answer 27

It records all transactions between a country and the rest of the world during a time period ( payment to foreigners in debit of the BP ( < 0 ) and receipt from foreigners in credit ( > 0 )

Question 28

Which three types of transactions are recorded in the Balance of Payments Accounting?

Answer 28

1) . Current Account CA - Transactions that involve goods and services.
2) . Financial Account FA - Transactions that involve financial assets ( any form in which wealth can be held, e.g. money, factories)
3) . Capital Account KA - Transfers of wealth between countries ( non-market activities, e.g. copyrights)

Every transaction enters the balance of balance of payments twice, one as credit and once as debit.

Question 29

The Fundamental Balance of Payments Identity

Answer 29

CA + FA + KA = 0

Question 30

The Financial Account

Answer 30

The financial account measures the difference between sales of assets to foreigners and purchases of assets bought abroad.

Question 31

Non reserve financial account: private transactions ( non-Central Banks)

Answer 31

“private” transactions ( non - Central Banks)

Question 32

Official Reserve Transactions

Answer 32

Central Bank Transactions