Balance of Payments

Question 1

What is balance of payments?

Answer 1

records all financial transactions made between consumers, businesses and the government in one country with other nations

Question 2

What is current account?

Answer 2

CA measures all the currency flow into and out of a country in a particular time period in in relation to trade in goods, trade in services, primary income and secondary income

Question 3

causes of current account deficit:

Answer 3

• poor price and non-price competitiveness: higher inflation than trading partners
• strong exchange rate affecting exports snd imports: high currency value = increase in price of exports, appreciating currency = imports cheaper
• recession in one or more major trade partner countries: cuts value of exports to these countries
• volatile global prices (commodities): exporters hit by fall in world prices, importing nations hit by higher prices of oil and gas

Question 4

causes of current account surplus:

Answer 4

• export-oriented growth
• foreign direct investment
• undervalued exchange rate
• high domestic saving rates
• strong investment income from overseas investment
• protectionism

Question 5

problems of persistent trade deficit:

Answer 5

• loss of AD which causes slower real GDP growth and reduced living standards
• loss of jobs in home-based industries, may lead to regional decline and structural unemployment problems
• need to import financial capital to achieve balance
• lead to currency weakness and higher inflation which can lead to capital flight/loss of consumer confidence
• may be a reflection of lack of competitiveness/supply-side weaknesses
• fall in exports will reduce AD and final impact on GDP, jobs and investment is amplified by the multiplier effect

Question 6

if the economy is operating near full capacity, a rise in the trade surplus might cause what? and draw a diagram:

Answer 6

might cause demand-pull inflation: keynesian supply curve where AD1 shifts out to AD2

Question 7

problems of trade surpluses:

Answer 7

• may lead to a threat of protectionism from trade deficit nations
• if surplus is due to high saving/low consumption, living standards might be too low
• may be the result of high-priced commodities- prices are volatile/unpredictable

Question 8

UK top 5 trading partners for imports:

Answer 8

Germany 
USA
Netherlands
China 
France

Question 9

UK top 5 trading partners for exports:

Answer 9

USA 
Germany 
France 
Netherlands
Ireland

Question 10

Reasons for trade deficit in goods:

Answer 10

• unbalanced economy: lower production of primary materials, decline in UK manufacturing sector
• high income elasticity of demand for imported goods and services
• weaknesses on supply-side of economy
• some businesses find it hard to finance a rise in exports
• less successful in exporting to emerging nations, majority of exports go to slower-growing countries
• strong currency makes imports of goods and services more affordable and exports less attractive to foreign buyers

Question 11

reasons for trade surplus in services:

Answer 11

• specialising in the provision of services (shift away from primary and secondary sectors towards tertiary sector employment)
• ^this means that UK is more competitive in the provision of these services and can offer better services at lower cost
• prime financial centres

Question 12

examples of cost competitiveness

Answer 12

differences in unit labour costs- reflected in producer prices

Question 13

examples of non-price competitiveness

Answer 13

product quality, design, marketing, reliability and performance

Question 14

examples of non-wage costs

Answer 14

costs of meeting environmental/health regulations
environmental taxes
employment protection laws and health and safety laws
requirements to provide pensions for employees

Question 15

reasons for UK’s lack of competitiveness:

Answer 15

• level of investment per capita in the UK is considerably lower than in other advanced economies
• use of IT in Europe lags behind that in the USA because of lower competition
• help to explain lower levels of R&D as compared with the USA
• poor level of UK investment in manufacturing: relatively low savings ratio, alternatives include; foreign direct investment, shares, property and service sector

Question 16

policies to reduce trade deficit:

Answer 16

Demand management:

• tightening of fiscal/monetary policy reduces real spending power of consumers, then lower spending on imports. achieved by cutting gov spending, raising interest rates and income tax
• leads to an increase in productive capacity

Lower exchange rate:

• improves competitiveness and reducing the overseas price of exports and making imports more expensive
• authorise intervention in the currency markets to manipulate the value of the currency

Supply-side improvements:

• policies to raise productivity: more innovation, incentives to increase investment in industries with export potential
• policies to encourage business start-ups
• investment in education and health-care to boost human capital and increase competitiveness
• investment in modern critical infrastructure
• protectionist measure such as tariffs

Question 17

the impact of policies to reduce the trade deficit and increase AD depends on what?

Answer 17

the amount of spare capacity in the economy

Question 18

if there is large negative output gap/spare capacity/cyclical unemployment then real economic growth can be achieved without what?

Answer 18

without much inflation

Question 19

if there is limited spare capacity: cost of real economic growth is high level of inflation. draw diagram

Answer 19

keynsian: LRAS, AD shifts out up straight bit of LRAS and creates inflation

Question 20

if greater foreign demand is a response to improved supply-side conditions, what happens to the curve? and what does this mean?

Answer 20

LRAS curve shifts to the right and AD shifts out.
-economy can produce and supply the goods needed to meet the increase in export demand without generating inflation. economy is benefiting from export-led growth