Balance of Payments AP/IB Economics

Meet the Costas’

Balance of Payments Account Sum of all the transactions that take place between its residents and the residents of all foreign nations over a period of time. Credit = $ in (+) Debit = $ out (-) Current account = goods + services + net income flows Financial/Capital account = assets Official reserves account = foreign currencies owned by central banks of nations, used to balance out BoP

Current Account Goods = visible trade balance Services = invisible trade balance Workpoint 24.1 p. 295 What is an invisible import, a visible import, an invisible export, and a visible export on the UK current account? UK computer manufacturers buy semi-conductors from Malaysia. Lloyds of London sells insurance to Chinese shipping companies. Canadian football fans buy tickets to a Manchester United game. British football fans attending the World Cup 2010 stay in hotels in South Africa. France buys North Sea natural gas from UK companies.

Current Account Factor Income = use of factors of production owned by residents of other countries (profit, interest, and dividends from financial investment abroad) Transfers = net transfers of money that are not as payment for goods or services (foreign aid, grants, remittances, gifts) CURRENT ACCOUNT = balance of trade in goods + balance of trade in services + factor income flows + transfers

Net errors and omissions Financial Account Net change in foreign ownership of domestic financial assets Direct investment Portfolio investment Reserve assets Financial account + Net errors and omissions Current account

Crud… What’s the difference?? CURRENT ACCOUNT FINANCIAL ACCOUNT The transactions end No liability is created 1 and done Transactions continue Creates a liability

US BoP figures 2007 2008 2009 Exports of goods 1,160,366 1,304,896 1,068,499 Imports of goods -1,983,558 -2,139,548 -1,575,443 Balance of trade in goods -823,192 -834,652 -506,944 Exports of services 488,299 534,116 502,298 Imports of services -367,206 -398,266 -370,262 Balance of trade in services 121,093 135,850 132,036 Income receipts 829,602 796,528 588,203 Income payments -730,049 -644,554 -466,783 Net income receipts 99,553 151,974 121,420 Unilateral current transfers -115,548 -122,026 -124,944 Net income flows -15,995 29,948 -3,524 Current account balance -718,094 -668,854 -378,432 Capital account transactions 384 6,010 -140 US-owned assets abroad -1,475,719 156,077 -140,465 Foreign-owned assets in USA 2,107,655 454,722 305,736 Financial derivatives 6,222 -32,947 50,804 Statistical discrepancy 79,552 84,992 162,497 Financial account balance 718,094 668,854 378,432

US Trade Surplus and Deficit

Simulation Time! Welcome to Eaststan or Weststan!

Self-correcting Balance of Trade $  X  M  X  M  .: XN  .: XN  $ 

Self-correcting Balance of Trade $  X  M  X  M  .: XN  .: XN  $ 

AP FRQ 2008 2. Balance of payments accounts record all of a country’s international transactions during a year. (a) Two major subaccounts in the balance of payments accounts are the current account and the capital account. In which of these subaccounts will each of the following transactions be recorded? (i) A United States resident buys chocolate from Belgium. (ii) A United States manufacturer buys computer equipment from Japan. (b) How would an increase in the real income in the United States affect the United States current account balance? Explain. (c) Using a correctly labeled graph of the foreign exchange market for the United States dollar, show how an increase in United States firms’ direct investment in India will affect the value of the United States dollar relative to the Indian currency (the rupee).

6 points (2 + 2 + 2) (a) 2 points: • One point is earned for stating that the transaction will be recorded in the current account. (b) 2 points: • One point is earned for stating that the current account balance will decrease or move toward a deficit. • One point is earned for explaining that the increase in income causes imports to increase. (c) 2 points: • One point is earned for a correctly labeled graph of the foreign exchange market for the U.S. dollar. • One point is earned for shifting the supply of U.S. dollars to the right and showing a depreciation of the dollar.

AP FRQ: 2008 form B 2. Suppose that Mexico decreases its tariff rates on all of its imports of automobiles from abroad. (a) Will each of the following groups benefit from the decrease in the tariff rate? (i) Mexican consumers (ii) Mexican automobile manufacturers. Explain. (b) How would the decrease in the tariff rates affect each of the following in Mexico? (i) Current account balance. Explain. (ii) Capital account balance (c) Given the change in Mexico’s current account in part (b)(i), what will happen to the aggregate demand in Mexico?

7 points (3 + 3 + 1) (a) 3 points: • One point is earned for stating yes for Mexican consumers. • One point is earned for stating no for Mexican manufacturers. • One point is earned for the explanation that reducing tariffs will cause the domestic price of automobiles to fall in Mexico, lowering the production of cars in Mexico. (b) 3 points: • One point is earned for indicating that the current account will move toward a deficit. • One point is earned for the explanation that the reduction in tariff increases imports relative to exports. • One point is earned for stating that the capital account will move toward a surplus. (c) 1 point: • One point is earned for concluding that aggregate demand will decrease.