NATIONAL INCOME

GDP: National Spending = National Income  Y=C+I+G+X–M  Y = GDP; C = Consumption; I = Physical Investment; G = Government Spending; X = Exports; M = Imports  GNP  NNP  Current prices  Constant prices

BALANCE OF PAYMENTS

WHY DO COUNTRIES TRADE?
Trade is simply buying and selling goods and services from other countries.  Imports: The purchase of goods and services from foreign countries leading to outflow of currency.  Export: The sale of goods and services leading to inflow of foreign currencies.  But what really prompts countries to do these trades?

 Comparative Advantage    When a country can produce goods at lower opportunity cost i. When a country can produce goods with fewer resources than another country.WHY DO COUNTRIES TRADE? Different countries according to various factors have different levels of efficiency in producing different goods. Absolute Advantage  .e. it sacrifices less resources in production.

 Thus opportunity cost of producing additional Good2 is high in country A.5 .5 20 22.  Countries Country A Country B Total Good 1 5 10 15 Good 2 2.WHY DO COUNTRIES TRADE? A unit of labour can produce either 10 Good1 or 5 Good2 in country A. and opportunity cost for producing Good1 is higher in country B. and a unit of labour in country B can produce either 20 Good1 or 40 Good2.

Larger quantities will be produced and they will have mutual benefits.e.(Lets suppose still Country B produces good 1 due to fear of shortage) Countries Country A Country B Total Good 1 10 5 15 Good 2 0 30 30 .WHY DO COUNTRIES TRADE?    Now suppose the countries produce the goods in which they have minimum opportunity cost i. they achieve specialisation in the suitable good and then trade. Below is Table for such production.

which create the demand for.INTRODUCTION ABOUT BOP All modern economies prepare and publish this National Accounts. and the supply of the country’s currency.  .  A record of all the factors.

‖ The phrase ―residents of foreign countries‖ may often be replaced by ―nonresidents‖. . ―foreigners‖ or ―rest of the world (ROW)‖.DEFINATION ―The Balance of Payments of a country is a systematic accounting record of all economic transactions during a given period of time between the residents of the country and residents of foreign countries.

 .  Any transaction resulting in a receipt from foreigners is entered as a credit and is given a positive (+) sign.BALANCE OF PAYMENTS A country’s balance of payments accounts keep track of both its payments to and its receipts from foreigners.  Any transaction resulting in a payment to foreigners is entered in the balance of payments accounts as a debit and is given a negative (—) sign.

WHAT IS ECONOMIC TRANSACTIONS? By this we mean transfer of economic value from one economic agent (individual. business. government. etc.) to another.  .  Something in return.

One real transfer.THE FOLLOWING BASIC TYPES OF ECONOMIC TRANSACTIONS CAN BE IDENTIFIED: 1. Purchase or sale of goods or services with a financial quid pro quo. 5.g.or a promise to pay. A unilateral financial gift. A unilateral gift in kind. 2. One financial transfer. purchase of foreign securities with payment in cash or by a cheque drawn on a foreign deposit. 4. . Purchase or sale of goods or services in return for goods or services or a barter transaction. One real and one financial transfer. An exchange of financial items e. 3. Two financial transfers. Two real transfers.

(c) The Reserve Account: .COMPONENTS OF THE BALANCE OF PAYMENTS  (a) The Current Account: Under this are included imports and exports of goods and services and unilateral transfers of goods and services. (b) The Capital Account: Under this are grouped transactions leading to changes in foreign assets and liabilities of the country.

THE CURRENT ACCOUNT .

Cr Dr Net (b) Transfers 6 Official 7 Private  (c) Income (i) Investment Income (ii) Compensation to Employees Total Current Account (I + II)  .CONT.

THE CAPITAL ACCOUNT .

THE OTHER ACCOUNTS .

1 shows a discrepancy of $0.  Exhibit 3.73 billion in 2000.  .STATISTICAL DISCREPANCY There’s going to be some omissions and misrecorded transactions—so we use a ―plug‖ figure to get things to balance.

THE BALANCE OF PAYMENTS IDENTITY BCA + BKA + BRA = 0 where BCA = balance on current account BKA = balance on capital account BRA = balance on the reserves account Under a pure flexible exchange rate regime. BCA + BKA = 0 .

27) $10. BALANCE OF PAYMENTS DATA Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.809.64 $444.U.94) ($303.39) ($444.418.73 $0.18) ($64.S.30) ($152.39 $262.24 $1.68 $474.26 0.30 ($0.69) Debits .64 ($1.44) ($124.

30) ($152.26 0.64 ($1.68 $474. imported more than it exported.94) ($303. BALANCE OF PAYMENTS DATA Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287. thus running a current account deficit of $444.69 billion.69) Debits In 2000.73 $0.64 $444.S. the U.44) ($124.18) ($64. .27) $10.S.U.809.30 ($0.418.39 $262.24 $1.39) ($444.

S.S. .26 billion—clearly the rest of the world found the U.64 $444.24 $1.68 $474.27) $10.44) ($124.64 ($1. to be a good place to invest. BALANCE OF PAYMENTS DATA Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.809.69) Debits During the same year. the U.39) ($444.39 $262.U.94) ($303.26 0.S.30) ($152.418.30 ($0.18) ($64. attracted net investment of $444.73 $0.

39) ($444.68 $474.809.S.73 $0. .94) ($303.418.44) ($124.U.64 ($1.26 0.24 $1.18) ($64. BALANCE OF PAYMENTS DATA Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.69) Debits Under a pure flexible exchange rate regime.27) $10.30 ($0.30) ($152.64 $444. these numbers would balance each other out.39 $262.

73 $0.64 ($1. there is a statistical discrepancy.69) Debits In the real world.68 $474.27) $10.30) ($152.30 ($0.18) ($64.418. BALANCE OF PAYMENTS DATA Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.809.39) ($444.39 $262. .94) ($303.U.24 $1.S.44) ($124.64 $444.26 0.

64 ($1.44) ($124.30= –($0.809.18) ($64.64 $444.26 0.68 $474.30) ($152.S. BALANCE OF PAYMENTS DATA Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.24 $1.27) $10.69) + $444.30 ($0. the balance of payments identity should hold: BCA + BKA = – BRA ($444.69) Debits Including that.73 $0.94) ($303.73 = $0.U.39 $262.418.30) .39) ($444.26 + $0.

26 0.418.44) ($124.64 $444.24 $1.69) Debits Exchange rate $ P S D Q .73 $0.94) ($303.39 $262.39) ($444.30) ($152.30 ($0.68 $474.64 ($1.27) $10.BALANCE OF PAYMENTS AND THE EXCHANGE RATE Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.809.18) ($64.

24 $1.64 ($1.39 $262.18) ($64.418.BALANCE OF PAYMENTS AND THE EXCHANGE RATE Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.S.44) ($124.69) Debits Exchange rate $ P S D Q As U.94) ($303.30) ($152. . they are supply dollars to the FOREX market.68 $474. citizens import.27) $10.26 0.809.73 $0.30 ($0.39) ($444.64 $444.

18) ($64.S.30 ($0.26 0.418.69) Debits Exchange rate $ P S S1 D Q As the U.94) ($303.27) $10.39 $262. .44) ($124.68 $474.30) ($152.809.64 $444.24 $1. government sells dollars.64 ($1.BALANCE OF PAYMENTS AND THE EXCHANGE RATE Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.39) ($444. the supply of dollars increases.73 $0.

ACCOUNTING PRINCIPLES IN BALANCE OF PAYMENTS One credit & One debit. of dr.  . of cr must match Tt.  Tt.

RULE A All transactions which lead to an immediate or prospective payment from the rest of the world (ROW) i.e. residents of that country.e.either the payment will be credited to a bank account held abroad by a resident entity or a claim is acquired on a foreign entity. Thus an increase in foreign assets (or a decrease in foreign liabilities) must appear as a debit entry  . to the country in question i.  A payment received from the ROW increases the country’s foreign assets . should be recorded as credit entries in the BOP of that country and vice versa. nonresidents.CONT.

 .RULE B A transaction which results in an increase in demand for foreign exchange or decrease in supply of foreign exchange is to be recorded as a debit entry (imports)  while a transaction which results in an increase in the supply of (or decrease in demand for) foreign exchange is to be recorded as a credit entry.

g. when a resident purchases foreign securities or pays off a foreign bank loan— uses up foreign exchange and hence is a debit entry while a capital inflow e. . Capital outflow—e.g. disbursement of loan by a foreign bank to a resident firm increases availability of foreign exchange and therefore is a credit entry.

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 However. the United States has the world’s largest GNP. .  The United States is the world’s biggest debtor.BALANCE OF PAYMENTS  Case Study: Is the United States the World’s Biggest Debtor?  At the end of 1999. the United States had a negative net foreign wealth position far greater than that of any other single country.

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