The Balance of Payments and Exchange Rates

Question 1

Define Balance of Payments?

Answer 1

A record of all movements of money between an economy and the rest of the world

Question 2

What is the objective of balance of payments?

Answer 2

Balance of payments equilibrium: The amount of money leaving an economy (outflows) should be equal to the amount of money entering an economy (inflows)

Question 3

What are exports considered as?

Answer 3

Inflows

Question 4

What are Imports considered as?

Answer 4

Outflows

Question 5

What are some examples of Inflows and Outflows?

Answer 5

• Trade (exports/imports)
• aid
• Investment Income (money from investment abroad)
• Immigrant income
• Fees to/ Grants from
• FDI, Foreign Direct Investment (money to establish a business)

Question 6

What are the 3 accounts that all inflows and outflows are organised into?

Answer 6

• Current Account
• Capital Account
• Financial Account

Question 7

What inflows and outflows are included in the current account?

Answer 7

• Trade in goods
• Trade in services
• Investment income (includes interest on loans)
• Current transfers (includes fees to/grants from and insurance premiums)

Question 8

Reasons for a trade deficit?

Answer 8

• Factor endowments (land, labour, capital)
• Lower prices in competitor economies
• quality of goods
• Marketing skills

Question 9

What is the problem with having a balance of payments deficit?

Answer 9

• Concern is expressed when the economy relies on borrowing from overseas banks, this represents an increase in the UK’s external debt, upon which interest must be paid out of future export earnings.
• fall in AD as imports increase
• loss of jobs in home businesses
• loss on investor confidence
• can lead to currency weakness and higher inflation

Question 10

What is the concern with having a Balance of Payments surplus?

Answer 10

• A surplus means that resources have been directed away from domestic spending to meet the overseas demand for exports
• can lead to inflation

Question 11

Define exchange rate?

Answer 11

An exchange rate is the price of a currency measured in terms of some other currency.

Question 12

In a supply and demand curve for a currency what does the demand curve represent and what does the supply curve represent?

Answer 12

• Demand curve- inflows

- Supply Curve- outflows

Question 13

As the value of a currency increases what is it said to be?

Answer 13

Stronger

Question 14

As the value of a currency decreases what is it said to be?

Answer 14

Weaker

Question 15

What are the strengths or weaknesses of currency based on?

Answer 15

Inflows and Outflows

Question 16

If lots of money is leaving an economy what is the currency said to be?

Answer 16

Weak

Question 17

If lots of money is entering an economy what is the currency said to be?

Answer 17

Strong

Question 18

What are the four determinants of shifting the demand and supply curve of currency?

Answer 18

1) Trade: Imports (supply), Exports (demand)
2) FDI: -Foreign Direct Investment
- Investment in the UK by foreigners (Demand)
- Investment outside UK by UK firms (Supply)
3) Interest Rates: Up (demand), Down (supply)
4) Speculation (gambling)

Question 19

If a currency is Weaker are Imports/ Exports cheaper or more expensive?

Answer 19

Currency Weaker:
Imports more expensive
Exports cheaper

Question 20

If a currency is stronger are Imports/Exports cheaper or more expensive?

Answer 20

Currency Stronger:
Imports cheaper
Exports more expensive

Question 21

What is the relationship between Rising and falling Inflows and Outflows and Rising and falling exchange rates?

Answer 21

• Inflows Up/ Outflows Down } Exchange rate rises

- Inflows down/Outflows Up } Exchange rate falls

Question 22

What are the consequences of excessive exchange rate movements?

Answer 22

It can generate uncertainty. This can hinder business planning. It can hamper current investment plans.

Question 23

What are the consequences of overvalued exchange rates and undervalued exchange rates?

Answer 23

• Overvalued exchange rates are high rates at which exports are uncompetitive.
• Undervalued exchange rates, although giving current competitiveness to exports, raise the cost of imports. This puts upwards pressure on domestic prices and wages, and in time erode this competitiveness.