2.5 Balance of Payments

from pmt notes and school notes

definition of BOP

record of transactions between one economy and the rest of the world

what is the main element of it

current account
capital account
finical account
net errors and omissions

what is the biggest section of it

the current account

what is the current account made of

trade in goods, trade in services, primary and secondary income

what is the definition of a current account defecit

a country importing more goods and services by value than its exports

examples of a country with a current account deficit

USA, UK. UK has 2nd biggest in the world, US has 1st
we are a net importer

examples of a current account surplus country

China, Germany.
they are net exporters, they export more than they import by value

what is trade in goods?

the exchange of tangible items between different countries via the processes of importing and exporting

movement of goods across borders for sale and purchase

definition of exports

goods produced in one country and sent to another for sale or use

definition of imports

goods brought into a country from another country for sale or use

examples of goods

cars, electronics, raw materials

define trade in services

the exchange of intangible products, or services, between a producer and a consumer across national borders

examples of services

professional services like legal or finical

what is the Uk’s main export

professional services, mainly education

key fact for UK exports

£949.4 billion worth of goods and services in the 12 month period ending in Aug 2026.
services were worth over £500bn annually

define the primary income

earnings from the provision of factors of production (CELL) by residents to non residents

define secondary income

one sided transfers of economic value. It is the redistribution of income
(e.g. sending money back home from the diaspora)

what is the capital account

transfer of ownership of fixed assets

what is the finical account

investments

example of secondary income

remittances
foreign aid

difference between primary and secondary income

the flow of earnings related to production
secondary income represents the transfer of funds that are not directly linked to production

the value of the UK’s current account in Q1 2024

£-23.8

three causes of a current account defecit

-a country is importing raw materials
-a rise in the exchange rate
-the domestic economy may be booming

how does importing raw materials lead to a current account defecit

however, it may be a self correcting deficit as the raw materials may be converted into finished goods, some of which are exported

raw materials may be used for production process

then the final goods created may be exported, meaning that the deficit may lower or even balance as net exports increase

how does a rise in exchange rate result in a defecit

will raise export prices and lower import prices

SPICED and WIPDEC

means that people are less likely to buy exported goods abroad as they are less willing and able to buy a higher priced goods, especially if it is an inelastic good

means that the country is likely to be a net importer

how does a booming domestic economy lead to a current account defecit

high incomes will be spent on imports, means the country may become a net importer

however, means that trade in goods/services/imports are reolved, meaning that the defecit may finally be balanced as imports increase

what is the most serious underlying reason for a deficit

a lack of price or quality competitiveness
in this case, the deficit will not be corrected without steps to improve the performances of the country’s firms

what are the issues that determine how big of a problem a current account deficit may be

its cause
its size
its duration
small self correcting deficit will be less of a problem than a large long term one from poor performance

what will a current account deficit do to AD

will make it shift left from ad to ad1
this is because it will make net exports (x-m) of the ad equation become negative
puts downward inflationary pressure on price from p to p1
causes contraction in SRAS
causes fall in real gdp from y to y1

causes of a current account surplus

a country’s products being very internationally competitive
is a country is in recession→ as its citizens will not be spending their money on home products or imports→ therefore, firms may find it difficult to sell at home and then compete more vigorously in the export market

what will a surplus do to ad

make it shift right as it makes a positive contribution