Balance of Payments (BOP) – AS/A LEVELS/IB/IAL
Balance of Payments (BOP) – AS/A LEVELS/IB/IAL
Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes
Balance of Payments (BOP)
The balance of payments (BOP) is a record of payments from one country to another.
Deficit
A balance of payment deficit occurs when payment outflows are greater than payment inflows.
Surplus
A balance of payment surplus occurs when payment inflows exceed outflows of payments.
The balance of payment consists of three accounts
- The current account
- The financial account
- The capital account
The current account
Trade in goods
These are tangible products that you can see or touch such as cars, food and cloths.
United Kingdom (UK) is a majority net importer of goods such as computers, machinery and oil.
Trade in services
These are intangible products such as accounting, law, finance and insurance. The UK is a net exporter of services.
Investment income (IPD) – Interest, profit & dividends
This account consists of any interest, profit or dividends earned from investments abroad.
Transfers
These are payments made abroad which aren’t for goods and services or investments abroad. Transfers include payments made to the European Union or payments made to family members abroad.
Causes of a balance of payments deficit
- A strong pound would encourage more imports than exports
- Quality of UK goods being poor would make UK exports less competitive
- Higher rates of inflation would make the UK’s exports less competitive
- Higher wages compared to other countries could make the UK’s goods more expensive and less competitive
Causes of a current account surplus
- Lower wages compared to other countries could make UK products cheaper and more competitive
- A weak pound could make UK’s exports more competitive
- High quality products could make a countries exports more competitive e.g. German cars
- Highly skilled workers could encourage more services being exported e.g. specialist lawyers & financial accountants
- Low inflation rates could make UK goods cheaper than other countries
The Relationship between Current Account Imbalances and other Macroeconomic Objectives
- High Economic Growth – higher economic growth means that imports will increase due to a rise in demand for those goods / services, causing the current account deficit to grow
- Higher Export led growth can result in Inflation – by exporting more goods / services, economic growth and employment will rise, improving the current account balance. However, this would also lead to demand-pull inflation.
Measures to reduce a country’s imbalances on the current account
Demand-Side Policies
Monetary and Fiscal Policies can be used to reduce imports – household incomes fall, reducing the demand for imports and aggregate demand in the economy
Imports tend to have a high income elasticity – hence, it should be effective
However, these policies are short term and could lead to a fall in living standards as there is a reduction in output
Supply Side Policies
Policies to improve productivity, efficiency, and quality. Industries would be encouraged to exploit opportunities in the export market abroad and focus their resources in areas where there is a comparative advantage
These policies are long-term and will therefore take longer to come into effect
Significance of Global Trade imbalances
- It can be argued that the current account imbalance is not much of a problem as long as there is a surplus on the capital and financial account
- The Financial Crisis in 2008 showed how quickly the capital account can change
- Brexit increased the uncertainty and concern towards the Balance of Payments due to fears regarding the response of the financial markets
- Global imbalances can be measured in two ways – imbalances on the current account and imbalances in the assets / borrowing owned abroad
- If foreign investors refuse to lend money to a country, problems are likely to arise
The Interconnectedness of Economies
The Economy has become increasingly interconnected due to Globalisation
- Technology – access to more technology has allowed for goods / services to be shared on a faster basis
- Migration – there is increasing migration between countries
- Global Investment – more people and companies own assets in other countries
- International Trading – the proportion of output in an economy which is traded internationally is growing
AQA Spec – Additional Content
The significance of deficits and surpluses for an individual economy
- Current Account deficits and surpluses could demonstrate an unbalanced economy and that the country relies on other countries for its growth
- Higher costs of imported raw materials could indicate cost-push inflation
- International Trade suggests that countries have become more interdependent
- There can be difficulties in attracting financial flows to finance a current account deficit
Quick Fire Quiz – Knowledge Check
1. Define what is meant be ‘the balance of payments’ (BOP) (2 marks)
2. State what a surplus is on the BOP (2 marks)
3. State what a deficit is on the BOP (2 mark)
4. Identify and explain what the four accounts within the current account of the balance of payments are (8 marks)
5. Identify and explain 2 causes of an imbalance of payments (4 marks)
6. Identify and explain 2 costs of an imbalance of payments (4 marks)
7. Explain the relationship between Current Account imbalances and other Macroeconomic Objectives (4 marks)
8. Explain how the Economy has become increasingly interconnected (4 marks)
9. Identify and explain two measures to reduce a country’s imbalances on the current account (4 marks)
10. Explain the significance of Global Trade Imbalances (4 marks)
Next Revision Topics:
- Exports / Imports (Trade)
- Economic Growth – Causes / Benefits / Costs
- Investment
- Inflation
- Aggregate Demand
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