Lesson 28- Balance of payments on the current account Flashcards
Define the BOP
An account of transactions between one country and the rest of the world during a year.
What is the BOP divided into?
Current account
Capital account
Define current account
The current account consists of exports and imports of goods and services.
Visible Balance/Balance of Trade/Trade in goods balance
The difference between the export and imports of goods
Invisible Balance
The difference between exports and imports of services
When would there be a surplus in the current account of the BOP?
When the export of goods and services is greater than exports of goods and services.
When would there be a deficit in the current account of the BOP?
When imports of goods are greater than exports of goods and services.
When would it be considered unharmful for a economy to have a deficit on the visible balance?
As long as it can be compensated by a surplus on the invisible balance.
What are the ways to reduce a BOP deficit? (4)
1.Devaluation
2.Deflation
3.Interest rates
4.Protectionism
Explain how devaluation can be used to reduce a BOP deficit?
When the government devalues the currency it will be cheaper for the foreigners to buy more goods from that country.
On the other hand, when the currency is devalued it will be difficult for importers of that country to import more because the currency is now cheaper and they have to pay more to obtain the same basket of goods.
Define the term Devaluation
This refers to the deliberate reduction in the external value of a currency by the government.
Define the term deflation
This refers to a situation when the government of a country reduces the aggregate demand deliberately using fiscal and monetary variable in order to reduce the demand for imports.
How can deflation be used to reduce a deficit in the BOP
When the govt uses fiscal and monetary policy to reduce AD the demand for imports will fall therefore the deficit on the current account will fall.
What is a consequence of using deflation to reduce the deficit in the BOP?
When the aggregate demand of a country falls, not only will demand for imports fall but the demand for domestic products will also fall.
How are interest rates used to reduce a BOP deficit?
The govt will increase the interest rates given by the banks to lenders, this is done in order to discourage borrowing and encourage saving. When people save more, they will spend less.
How can protectionism be used to reduce a deficit in the BOP?
They govt can use various methods of protectionism such as tariffs, quotas and embargos to protect a country from the harmful effects of imports.
Explain 4 effects of a BOP deficit on a country?
1.A country will encounter a fall in its foreign exchange reserves as most of the money will be spent on its imports. Therefore funds will not be available to spend on essential imports like food and medicine
2.The govt loses money in the form o taxes had the money been spent within the country instead on imports. This makes it difficult for the govt to spend on infrastructure, provision of public and merit goods.
3. There will be unemployment since consumers will be buying foreign goods instead of local goods. This will compel local firms to reduce their labour force.
4. Since local firms produce less the AS of the economy will be low leading to negative economic growth.
What are the reasons for a BOP deficit?
1.Poor quality domestically produced goods
2. Price of domestically produced goods
3. Exchange rates
What are the evaluations for a BOP deficit?
1.If the deficit was caused as a result of importing capital goods, then in the long run the productive capacity will increase enabling the country to export and recover the deficit
2.A deficit on the BOP may not be a serious problem if it can be financed by a surplus on the capital account.
3. A deficit on the BOP will improve living standards of the country if more consumer goods were imported.
4. Local manufacturing firms will benefit in the form of lower factor input costs if raw materials were imported. The outcome of lower prices for consumers and also exports may increase if these goods are sold abroad.
