Balance Of Payments Notes PDF

CAIE AS Level Economics notes for Balance of Payments (BOP): 1. Definition of Balance of Payments (BOP): The BOP is a financial record of all economic transactions made between residents of a country and the rest of the world over a specific period. These transactions include trade, services, i...

CAIE AS Level Economics notes for Balance of Payments (BOP): 1. Definition of Balance of Payments (BOP): The BOP is a financial record of all economic transactions made between residents of a country and the rest of the world over a specific period. These transactions include trade, services, investments, and capital transfers. 2. Structure of the Balance of Payments: The BOP is divided into three main accounts: a) Current Account The current account records the flow of goods, services, income, and current transfers. It consists of: 1. Trade in Goods (Visible Trade): Exports and imports of physical goods like machinery, food, and cars. A surplus occurs when exports > imports. A deficit occurs when imports > exports.  2. Trade in Services (Invisible Trade): Exports and imports of services such as tourism, banking, insurance, and shipping. 3. Primary Income: Income from investments abroad (e.g., dividends, interest, profits). Payment of income to foreign investors. 4. Secondary Income (Current Transfers): Transfers of money without exchange of goods or services. Includes remittances, foreign aid, and pensions. b) Capital and Financial Account This account tracks the flow of funds for investment purposes and other financial transfers. 1. Capital Account: Records one-off transactions, such as: Debt forgiveness. Inheritance taxes. Transfers of ownership of fixed assets (e.g., land). 2. Financial Account: Tracks transactions involving financial assets and liabilities, such as: Foreign Direct Investment (FDI): Purchase of physical assets in another country. Portfolio Investment: Investment in stocks and bonds. Reserves: Government holdings of foreign currencies and gold. Loans and Banking Flows: Borrowing and lending across borders.  c) Errors and Omissions (Balancing Item): This account ensures that the BOP balances since data inaccuracies or unrecorded transactions can cause discrepancies. 3. Key Terms: Surplus: When inflows (credits) exceed outflows (debits). Deficit: When outflows (debits) exceed inflows (credits). 4. Causes of a Current Account Deficit: 1. High Levels of Imports: Domestic consumers prefer foreign goods (e.g., luxury products). 2. Weak Export Demand: Domestic goods are uncompetitive in terms of price or quality. 3. Appreciation of Currency: Makes exports expensive and imports cheaper. 4. Structural Issues: Lack of investment in productive sectors reduces export competitiveness. 5. Consequences of a Current Account Deficit: 1. Depreciation of Currency: High demand for foreign currency to pay for imports may reduce the value of the domestic currency. 2. Increased Borrowing: The country may need loans to finance the deficit, increasing external debt. 3. Impact on Economic Growth: Loss of domestic jobs in export industries. 6. Policies to Correct a Current Account Deficit: 1. Expenditure-Switching Policies: Encourage domestic consumption of local goods through: Tariffs. Quotas. Subsidies to exporters. 2. Expenditure-Reducing Policies: Reduce overall spending in the economy via: Higher taxes. Reduced government spending. Higher interest rates to discourage consumption. 3. Supply-Side Policies: Improve the competitiveness of domestic industries through: Training and education. Infrastructure investment. Technological development. 7. Causes of a Current Account Surplus: 1. High Export Demand: Competitive pricing or high-quality goods. 2. Low Import Levels: Protectionist measures or a preference for domestic goods. 3. Depreciation of Currency: Makes exports cheaper and imports more expensive.  8. Consequences of a Current Account Surplus: 1. Appreciation of Currency: High demand for the domestic currency may make exports more expensive. 2. Global Imbalances: Other countries may face deficits, leading to trade tensions. 3. Over-Reliance on Exports: The economy may become vulnerable to external shocks. 9. Importance of Balance of Payments:  1. Indicator of Economic Health: Surpluses show competitiveness; deficits may indicate structural issues. 2. Affects Exchange Rates: Persistent imbalances influence currency stability. 3. Guides Economic Policy: Deficits may prompt corrective measures like currency devaluation. 10. Example: Kenya’s Balance of Payments (BOP): Kenya often runs a current account deficit due to high import levels (machinery, oil) exceeding exports (tea, coffee, flowers). To finance the deficit, Kenya relies on foreign investment, loans, and remittances.