Balance of Payments

Question 1

What are the measures to reduce a current account deficit?

Answer 1

1. Protectionist policy
2. Supply side policies
3. Policies to weaken exchange rate

Question 2

What are the components of the current account? Please describe

Answer 2

Trade in Goods: Exports and imports of physical goods.

Trade in Services: Transactions involving services like tourism, financial, and consulting services.

Income: Earnings from foreign investments and payments to foreign investors.

Transfers: Unilateral transfers, such as foreign aid or remittances from workers abroad.

Question 3

What are the components of the financial and capital account? Please describe

Answer 3

Capital Account: Records capital transfers, usually debt forgiveness

Financial Account: Tracks financial assests flows in and outs

Question 4

define current account

Answer 4

The part of the Balance of Payment. It measures in the trade of goods and services, investment income and current transfers.

Question 5

What are the causes of Deficits

aim for 3

Answer 5

1. Economic growth:
   rise in income -> demand for luxury good increases -> demand for import increases -> value of import > value of export -> current account deficit

EV:
1. depends on MPM, UK have high MPM.
2. Cause of economic growth, China/Germany growth through exports -> current account surplus

2. Exchange rate:
   Value of currency appreciates -> purchasing power of the currency in the form of another increases -> value of import appears cheaper -> consumers maximise utility -> expansion in the quantity demand for imports -> Value of imports increases -> value of import > export -> current account worsens

EV:
1. depreciation in long run
- more import -> increases supply of currency in market exchange -> decreases value of currency -> value of exports appears cheaper

3. Competitiveness
   - low productivity/poor infrastructure/poor training/strict labour laws e.g. minimum wage -> unit labour cost rises -> cost of production rises -> price increase to retain profit margins -> competitiveness relatively weaker internationally -> value of export decreases, import increases (consumers maximise utility) -> current account deficit

Ev
3. Non price factors, PED < 1/High quality, personalised service/product may retain significant quantity demand, where change in %QD < %Price, while enjoying higher profits from higher price

4. Increase in labour productivity may counter-balance higher unit labour cost to the cost of production

Question 6

What are the causes for surplus

aim for 3

Answer 6

1. Economic recession (lowers income -> lower demand for normal/luxury goods -> demand for imports decreases…)
2. Weakened currency
3. High competitiveness

Question 7

Measures to reduce current account deficit

Answer 7

Policies to weaken exchange rates: A depreciating currency can make exports cheaper and imports more expensive, improving the trade balance.

Fiscal Policy: Governments can reduce budget deficits to increase national savings and reduce reliance on foreign borrowing.

Protectionist policy: Reducing imports through tariffs, quotas to encourage more domestic production

Supply side policies: subsidies encouraging innovation and productivity improvements can enhance competitiveness in global markets.

Question 8

What factors does a current account imbalance impact on?

List 2

Answer 8

Exchange Rate: contribute to currency fluctuations, affecting trade and investment.

Impact on AD