AS Economics (Macro)

Chapter 9
Balance of Payments

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 Transactions

• Inflow of money BoP deficits are when inflows of money are less than outflows
BoP surplus is vice versa. Both are disequilibria.
Credit items (exports)

• (Outflow of money
Debit items (imports )

Balance of payment equilibrium

fish-Eating
BoP ~ of Current Account Deficit (X<M)

Balance of Payments

Capital a/c Financial a/c

Current account
All transactions in non-produced/ All transactions in produced/financial assets
Components
non-financial assets. e.g land, 1)Direct investment e.g machines, buildings
trademark copyrights, money
brought by migrants 2) Portfolio investment eg shares, bonds

3) loans and deposits

Visible trade
(Trade in goods) +
export of goods—
import of goods
This is known as
balance of trade
in goods
Invisible Trade
Primary income account + Secondary income
(Trade in services) +
e.g dividends, profits, interest, account (current
export of services—
income earned by local FoPs transfers)
import of services e.g
abroad, income earned by foreign All transactions involving
tourism, insurance
This is known as balance FoPs locally non-productive activity
of trade in services e.g charity, aid

BoP equilibrium is when the sum of these three is zero or approximately zero. BoP disequilibrium is when the sum is further away from zero,
either in positive or negative values. In such a case the disequilibrium value is put in the ‘errors and omissions’ category, which becomes the
fourth category of BoP.

Causes of current account deficit ( ✗ < m)

1) Growing economy ;- increase in imports of raw materials + capital in short run + income increases and demand for

[
import increases 5. R cause

2) Declining foreign economies; income decreases and demand for exports also decreases * we

↑→Dm↑→caD↑
① Employment ↑ →
incomes

② Output ↑→Drm↑→Dm↑→
it

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LGS Gulberg A levels 2020-22
 Structural Problems LR cause

3)

High Inflation Low Factor Productivity

Overvalued
Inflation increase — price of Labour and capital efficiency decreases
Exchange rate export increases due to which due to which quality also decreases
demand of export decreases/ which leads to fall in aggregate supply
increase in exchange rate: price of export
demand for import increases and increase in cost
increase/price of import decrease in long run
which leads to an increase in
due to which export revenue decreases/import current account deficit
expenditure increases which creates current
account deficit

Prebisch - Singer hypothesis L R .

cause

4)

Developed Developing
-Secondary/Tertiary -Primary
-Price elasticity of demand and -Price elasticity of demand and income
income elasticity of demand (elastic) elasticity of demand (inelastic)

Over long run, income level increases in world due to which demand
of tertiary sector increase by a lot whereas the demand of primary
sector also increases but my small proportion

• As developed countries specialize • Developing countries specialize in primary goods

in tertiary good. Their income that’s why their income elasticity of demand is
elasticity is elastic due to which inelastic which increase the demand and leads to
demand increases by a lot and an small increase in export revenue and a large
export revenue also increases’ increase in import expenditure as their income
increases as they import secondary and tertiary
products which causes a rise in current account
deficit in long run

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LGS Gulberg A levels 2020-22
 Causes of Financial account Deficit

1) Decrease in inflows of profits, interest, of dividends

✓2) Decrease in foreign direct investment. ( MNCs ↓)

✓3) Capital flight due to lack of confidence in economy

-When is current account deficit problematic?

1) when Current account deficit is high and persistent

2) If Current account deficit is not covered by financial account surplus and instead by drawing foreign reserves on debt
accruing and increase in debt burden

3) Import burden too high which may also cause imported inflation

4) domestic industry suffers due to too many imports

5) Aggregate demand decreases due to current account deficit and there is decrease in gross
↑
domestic profit +
unemployment
.

6) May lead to poor relations with other countries

7) May lead to trade restrictive practices and policies by the govt of a country faced with high CAD

-Problems with current account surplus (X>M)

1. Domestic industries may suffer as exchange rate increases which will cause a fall in the
demand for exports as price of exports will increase

2. Bad relations as one country’s current account surplus measures another country’s
current account deficit

3. Inflationary pressure as current account surplus: demand pull inflation increases and
aggregate demand also increases.
4 CAS may mean
that a
country importing less
is
than
choice
compromising
.

thus consumer
what
they should standards
which lowers
living
'

SOHAIB ALAVI sohaib.alavi@gmail.com Typed by Momin Naeem

LGS Gulberg A levels 2020-22