Balance of Payments

27 flashcards · Economics · by Addaneye

1. What are the two components of the balance of payments?

   the current account the capital and financial account

2. What are the four components of the current account?

   Trade in goods Trade in services Investment income Current transfers

3. When will trade in goods and services appear as a positive and when will it appear as negative in the current account?

   Positive - Exports (injections) Negative - Imports (withdrawals/leakages)

4. What is investment income?

   Profits earned from investments made abroad

5. What is current transfers

   When money enters or leaves a country without being exchange for goods or services. (e.g. remittances, aid)

6. What are six factors that affect the current account?

   Exchange rate Relative inflation Productivity and costs Quality Growth Protectionism

7. How does the exchange rate affect the current account?

   Appreciation >SPICED >imports cheaper >import expenditure rises / exports dearer >export revenue will decrease >> current account will worsen Depreciation >WPIDEC >imports dearer > import expenditure will decrease/ exports cheaper >export revenue will decrease >>current account will improve

8. How does relative inflation affect the current account?

   If a country has a lower relative inflation, consumers will choose to buy from them leading to an increase in export revenue which will improve the current account

9. How does productivity and costs affect the current account?

   High productivity leads to lower costs per unit which means lower prices and an increase in exports which will improve the current account

10. How does quality affect the current account?

    Countries selling higher quality goods will have higher levels of demand meaning higher export levels meaning higher export revenue meaning they will experience an improvement on the current account

11. How does growth affect the current account?

    If a country experiences economic growth, its national income will increase meaning more normal goods being imported which means higher import expenditure meaning the current account will worsen

12. How does protectionism affect the current account?

    Protectionism will increase the price of imported goods meaning there will be lower levels of import expenditure meaning the current account will improve

13. How might a current account deficit affect AD?

    Current account deficit caused by a negative trade balance > exports have fallen and imports have risen> AD will fall >lower real GDP >lower living standards and higher unemployment.

14. When might a change in the current account have minimal or non-existent effects on GDP? (ev.)

    If the current account is only a small % of a country's GDP ^ e.g. if a country starts at full employment in the long run, a change in AD may have no effect on its GDP

15. How might a current account deficit affect the exchange rate?

    A current account deficit >import expenditure is high and export revenue is low >a fall in the demand for the currency/increase in the supply for the currency >depreciation of the currency

16. How might a depreciation of a currency lead to severe depreciation of that currency?

    Depreciation of a currency >investors lose confidence> sell that currency> increasing supply> depreciating currency

17. How might a depreciation of a currency then lead to an appreciation of the currency? (ev.)

    A deprecation of a currency >WPIDEC >exports cheaper >increase in demand for currency >appreciation of currency

18. How might a current account surplus affect AD?

    A current account surplus >positive trade balance >higher export revenue/lower import expenditure >AD will rise >higher real GDP >higher living standards and lower unemployment

19. How might a current account surplus negatively affect AD? (ev.)

    A current account surplus >positive trade balance> higher export revenue/lower import expenditure > country relies on export revenue >focuses on goods for foreign consumers> lower domestic consumer choice >lower living standards

20. What 3 types of policies might governments implement to improve current account deficits?

    Expenditure-reducing policies Expenditure-switching policies Supply-side policies

21. What are two expenditure-reducing policies and how might they reduce current account deficits?

    Raising income tax and reducing benefits >reduction in disposable income >reduction in consumer spending >fall in import expenditure > reduce current account deficit

22. Negative impact of expenditure-reducing policies (ev.)

    Reduction in consumer spending >reduction in standard of living

23. What are the two types of expenditure-switching policies?

    Trade barriers Lower interest rates

24. How might trade barriers help reduce a current account deficit?

    Trade barriers increase price of imported goods >increase domestic supply >decrease number of imports >switching trade from foreign to domestic producers

25. How might lower interest rates help reduce a current account deficit?

    Lower interest rates >outflow of hot money >decrease in demand/increase in supply of currency >depreciate currency >imports more expensive >consumers will switch to domestic goods

26. What are some examples of supply-side policies?

    Lower corporation tax Government spending on education Reducing minimum wage

27. How might supply side policies help reduce a current account deficit?

    Supply side policies >increase SRAS/LRAS >decrease PL >cheap and competitive domestic goods >increase in exports demanded/decrease in imports demanded >increase export revenue/decrease import expenditure >improvement in current account deficit