Power point presentation on IB economics notes

1. THE BALANCE OF
PAYMENTS
BY SUSAN ABUTO

2. THE STRUCTURE OF THE BALANCE
OF PAYMENTS
• OBJECTIVES
1. Define the term ‘balance of payments’
2. Outline the role of balance of payments
3. Distinguish between debit items and credit items in the
balance of payments
HOMEWORK: components of B.O.P accounts

3. Definition
Balance of payments(BOP)
refers to a record of the value of
all transactions of a country
with the rest of the world over a
period of time.

4. Role of BOP
• It shows all payments received from
transactions with other countries,
called CREDIT
• It shows all payments made from
transactions to other countries, called
DEBIT

5. Distinguish between credit and
debit items in a BOP
CREDIT
DEBIT
• Any transactions that
lead to money entering
the country from
abroad e.g. export
goods such as cash
crops, food crops,
manufactured goods,
etc
• exportation of
services such as
tourism, skills, etc
• It gives a positive
value
• Any transactions that
lead to money leaving
the country to go abroad
e.g. import goods such
as food items,
manufactured goods,
machinery, etc
• Importation of services
such as tourism,
expertise, insurance, etc
• It gives a negative value

6. COMPONENTS OF BOP
1. CURRENT ACCOUNT
It is a measure of the flow of funds from trade in goods and
services, plus other income flows
It is divided into FOUR components:
• Balance of trade in goods/ Visible trade
balance/Merchandise account/Balance of trade
• Balance of trade in services/ Invisible trade balance/Net
services
• Income/Net investment income
• Current transfers

7. Balance of trade in goods/ Visible trade
balance/Merchandise account/Balance of trade
• It measures the revenue received from the export of
tangible goods minus the expenditure on the imports of
tangible goods over a given time period
• NOTE:
• Exports lead to inflow of money while imports lead to an
out flow of money
• There is a surplus when X>M
• There is a deficit when M>X

8. Balance of trade in service/ Invisible trade
balance/Service balance/Net services
• It measures the revenue received from the export of
services minus the expenditure on the imports of
services over a given time period
Examples of these services include:
• Banking
• Insurance
• Tourism
• Transport
• Postal and courier services
• Communication services
• Financial services

9. Income/Net investment income
• It is a measure of the net monetary movement of profit,
interest, and dividends moving into and out of the country
over a given period of time, as a result of financial
investment abroad.
• Examples:
• Profits, Interests and Dividends from portfolio
• Direct investments
• Compensation of employees (wages and salaries)
• Returns from rental resources e.g. granting fishing,
grazing mining, and forestry rights.

10. Current transfers
• It is a measurement of the net transfers of money, often
known as net unilateral transfers from abroad.
• It refers to transfers with nothing received in return
•
•
•
•
•
•
Examples:
Worker’s remittances
Donations
Grants
Foreign aid
Food aid and emergency aid after natural disasters.

11. The sum of net export of goods and
services, net income and net current
transfers over a period of time is defined
as current account balance.
It is referred to as a current account
surplus if it is positive while a current
account deficit if it is negative.

12. NOTE:
• The current account of the balance of
payments of a country is composed of the
sum of the balance of trade (recording
exports minus imports of goods) plus the
balance on service, or invisible balance
(recording exports of service minus imports
of services), plus net income plus net
transfers.
• The most important part of the current
account in most countries is the balance of
trade.

13. CAPITAL ACCOUNT
This section of the BOP includes the following:
1. Capital transfers receivable and payable i.e. the net
monetary movements gained or lost through actions
such as the transfer of goods and financial assets
by migrants entering or leaving the country.
Note: These items of value that have not been produced
e.g. land or natural resources.
Other examples include:
• Gift taxes
• Inheritance taxes
• Death duties
• Debt forgiveness

14. 2. Transaction in non – produced, non- financial assets
This consists of the net international sales and
purchases of non – produced assets such as land and
the rights to natural resources, and the net international
sales and purchases if intangible assets such as patents,
copyrights, brand names or franchises.
NOTE: THE CAPITAL ACCOUNT IS SMALL AND OF
MINOR IMPORTANCE

15. FINANCIAL ACCOUNT
• This account includes investments and assets.
• It measures the net change in foreign ownership of
domestic financial assets.
• If foreign ownership of domestic financial assets >
domestic ownership of foreign financial assets, then
there is more money coming into the country than
going out and so there is a financial account
surplus.
• The vice versa leads to a financial account deficit.

16. COMPONENTS OF THE FINANCIAL
ACCOUNT
1. Direct investment: this is also referred to as Foreign
Direct Investment (FDI) when a resident in one country
acquires control or a significant degree of influence on
the management of a firm in another economy
(normally more than 10%)
• It is a measure of the purchase of long – term assets.
• It includes things such as:
Buying of property
Outright purchasing of a business
Purchasing of stocks or shares in a business.

17. 2. PORTFOLIO INVESTMENT
It refers to a measure of stock and bond purchases – these
do not lead to a lasting interest in a company.
It includes:
• Treasury bills
• Government bonds
• Saving account deposits
NOTE: THESE ASSETS ARE SIMPLY BORROWING AND
LENDING ON THE INTERNATIONAL MARKET.

18. 3. RESERVE ASSETS/ OFFICIAL
RESERVES
This includes the assets that the Central Bank
holds to finance balance of payments needs
and to intervene in the foreign exchange
market
• It includes the reserves of gold and foreign
currencies which all countries hold.
• It is movements into and out of this account
that ensures that the BOPs will always

19. CURRENT ACCOUNT =
CAPITAL ACCOUNT +
FINANCIAL ACCOUNT+
NET ERRORS AND
OMISSIONS

20. RELATIONSHIP BETWEEN CURRENT
ACCOUNT AND THE EXCHANGE RATES
• A deficit in the current account of the
BOP results in a downward pressure
on the exchange rate of a currency.
• This mostly affects the fixed exchange
rate more than the floating exchange
rate.
• A surplus in the current account of the
BOP may result in an upward pressure
on the exchange rate of the currency.

21. HL: CONSEQUENCES OF CURRENT
ACCOUNT AND CAPITAL IMBALANCES
CONSEQUENCES OF A CURRENT
ACCOUNT DEFICIT
• If the current account is in deficit, the capital
account will have to be in surplus in order
balance the current account benefit.
• It means the economy is not earning enough
FOREX from its imports and income
earnings from abroad to finance its imports.

22. SOLUTION
1. Running down FOREX reserves – this can only be
down for a short period of time because these reserves
are limited.
2. Surplus from the combined Capital and Finance
Accounts:
• This can only be done it two ways:
a) Sale of domestic assets (businesses, stock or property)
to foreigners – they might want at low prices. This may
lead to loss of economic sovereignty.
b) Borrowing from abroad – this involves future
repayment either in the short or long run – opportunity
cost will be diversion in the future of national income;
since repayment is in FOREX and this implies
diversion away from purchase of import consumer or

23. METHODS OF CORRECTING A PERSISTENT
CURRENT ACCOUNT DEFICIT
1. Expenditure reducing strategies – this
includes policies that decrease AD ( decrease
spending on imports), for example
contractionary fiscal and monetary policies.
Decrease in AD will lead to decrease in
inflation, exports may benefit from increased
competitiveness.
• Shrinking imports and increasing exports will
help narrow the current account deficit.

24. 2. Expenditure switching policies this includes devaluation, as well as
increased trade protection that renders
imports more expensive.
• NOTE – devaluation increases exports
but may leads to inflation.
• Trade protection restricts imports but
may lead to trade friction.

25. 3. Supply – side policies – these are
more of a long run nature and they
include decreasing domestic monopoly
power, increasing labor market flexibility
and improving incentives.
• They increase the competitiveness of
the economy and especially of the
export sector.

26. QUESTION?
IS A CURRENT
ACCOUNT
SURPLUS A
PROBLEM?
DISCUSS!

27. THE MARSHALL-LERNER
CONDITION
DEVALUATION (SHARP
DEPRECIATION) WILL
IMPROVE A TRADE
DEFICIT IF:
PED (X) + PED (M) > 1

28. • http://www.youtube.com/watch?v=VgCFN9M2aFE ( The
Marshall Lerner
• condition)

29. THE J – CURVE EFFECT
• http://www.youtube.com/watch?v=HSd7ybLJUuw (J –
curve)

30. REFERENCES
• Blink and Dorton, (2012), Economics: Course
Companion, Oxford University Press, New York
• Ziogas, C., (2012), IB study guide, Oxford university
Press, New York.
• Welker’s Wikinomics videos lectures.