7. Balance of Payments + Externalities + Inequality

What is the balance of payments?

Records all financial transactions between the UK + rest of the world including exports + imports

What are the three components of the balance of payments?

• Current account - trade of goods + services + primary income (money used in transactions) + secondary income (only 1 way - e.g aid)

• Capital account - capital transfers (e.g debt forgiveness) + non-financial assets (e.g patents)

• Financial account - movement of investments (e.g FDI, buying stocks)

What are two ways to balance the balance of payments?

If there’s a current account deficit, the gov needs a surplus in the capital/financial account by:

• Borrowing money from abroad

• Selling gold/foreign currency reserves

What are two short term + two long term reasons for the deficit in the current account?

Short term:

• Inflation

• Inelastic demand for imports

Long term:

• Productivity gap

• Switched from oil exporters to importers

What are two impacts of a deficit + two impacts of a surplus in the current account?

Deficit impacts:

• Decreased AD

• Increased unemployment

Surplus impacts:

• Decreasing foreign assets

• Indicates decreased competition + unsustainability

What is the acronym for exchange rates?

Stronger
Pound
Imports
Cheaper
Exports
Dearer

How can a change in the current account influence the exchange rate?

1. Inflation

2. UK goods are less price-competitive

3. Imports increase + exports decrease → current account worsens

4. Increased supply of pounds in the foreign exchange market (forex) to pay for imports

5. Pound depreciates

What are two advantages + two disadvantages of trade?

Adv:

• Specialisation

• Efficiency

• Choices

Dis:

• Overdependency/overspecialisation

• Decreased jobs (due to globalisation)

What are the four protectionist policies?

• Tariffs - tax on imports

• Quotas - restrictions on the quantity of product that can be imported

• Voluntary export restraint - exporting country voluntarily restricts the n. of goods it ships to a country

• Export subsidy - payment to a domestic producer who exports

What are two advantages + two disadvantages of protectionist policies?

Adv:

• Protecting domestic industries

• Control externalities

Dis:

• Inefficiency

• Risk of retaliation

What are three ways to reduce a current account deficit?

• Increased use of protectionist policies

• Join a single currency (e.g Euro)

• Decrease ER

• Increase IR

What is the J-curve?

In the SR, a depreciation of the ER can worsen the current account because of inelastic demand of imports + exports

What is the Marshall Lerner condition?

A depreciation of the ER will only have a positive effect on the current account if the sum of the elasticities of demand for exports + imports is negative + greater than 1

What does external cost mean?

Cost to a third party not involved in the economic decision

What are two ways to reduce externalities?

• Decrease AD (e.g decrease gov spending)

• Increase level of env-friendly tech

• Use policies like tradable permits

What does inequality mean?

Unequal distribution of income

What are two ways to reduce inequality?

• Benefit payments

• Progressive tax

• Education + training