Economics HL - Balance of Payments

Balance of Payments (BoP)

Record of all monetary inflows and outflows of a country (transactions in trade, income, transfers and capital flows) and the rest of the world over a given period of time

• The three main components: current account, the capital account and the financial account

Balance of Payments: Equation

BoP = Current account + Capital account + Financial account + balancing item (statistical errors) = O

Current Account: Definition

Record of transactions in exports, imports, transfers, and income flows between one country and the rest of the world over a given period of time

• Current Account = Balance of trade in goods + Balance of trade in Services + Net Income Flows + Net Transfers

• Either a surplus or a deficit

Current Account: Transaction Types

1. Balance of trade in goods = visible balance and refers to the difference between physical exports and physical imports

2. Balance of trade in services = invisible balance consisting of the balance of trade of services, such as tourism, flights, banking, architecture, website subscription, etc

3. Income = factor payments for the factors of production: profits, interest payments (from capital), dividends (gains from stocks)

   • Also called “net income” or “net factor income from abroad”

4. Current transfers = payment between one government and another that is not in exchange for any good or service

   • Also called “net unilateral transfers”

   • Example: foreign aid, remittances (workers sending wages back home, acts as a support for developing nations to fight poverty), grants

Current Account Deficit: Consequences

When revenue arising from the sale of exports, inflowing income and transfers is less than funds flowing overseas to pay for imports, outgoing income and transfers

• inflow revenue < outflow payments

• Current account = – (Capital account + Financial account)

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Current Account Surplus: Consequences

when the sum of the current account components are positive

• inflow revenue > outflow payments

• Current account = + (Capital account + Financial account)

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