Balance of Payments – AS Economics

Aims and Objectives Aim: Understand the importance of current account changes. Objectives: Define current account Explain why our trade balance is important Analyse changes in the current account Evaluate if a deficit matters

Starter Define the current account. What is the current state of the UK current account? Where are the UK’s main export destinations? Where are the UK’s main import destinations?

Why is our trade balance important? Effect on the macroeconomy Exports are an injection to circular flow Multiplier effect amplifies the effect of exports Employment Levels of employment in the secondary sector rely on exports Regional Disparities Areas such as the North and Midlands, rely heavily on manufacturing employment, a fall in exports would decrease employment and cause regional disparities

Current Account Changes Discuss in groups how each of the following can affect a country’s current account: Exchange Rates Changes in AD Inflation Labour Productivity Innovation

Exchange Rates Changes in AD Inflation Labour Productivity Innovation Prices of imports and exports affected, which affects consumer decisions. Changes in AD A rise in NI will result in increase in imports An increase in NI with UK trading partners will result in increased UK export demand Inflation If inflation is rising faster than trading partners, exports will fall. More goods will therefore be imported as they are cheaper! Labour Productivity Make a country more effective reducing prices of goods and services, increasing X. If trading partners more productive, then imports will rise. Innovation Will lead to new products, that will increase competitiveness of a country.

Current Account AD/AS Model PRICE LEVEL Current account surplus: shift from AD – AD1 Increase in real output and price level. If exports increase AD beyond AD2 this will be inflationary as economy pushed into a positive output gap. Increased exports benefit economy when negative output gap. But will add to inflationary pressure when in a positive output gap. AS AD2 AD1 P2 AD P1 P A B C REAL GDP

Current Account AD/AS Model PRICE LEVEL A deficit will have the reverse effect as AD will fall if demand for UK goods falls and demand for imports rises. This will contract the economy and reduce prices. AS AD2 AD1 P2 AD P1 P A B C REAL GDP

Does a deficit balance matter? The UK economy has a large deficit balance, does this actually matter?

Argument For Deficit may indicate that the UK has lost competitiveness due to insufficient investment. Continuous deficits leads to withdrawals from the circular flow that will reduce employment and NI. Loss of manufacturing jobs leads to structural unemployment.

Argument Against There is no problem as long as there is sufficient foreign investment in the UK to finance it. Some of the deficit may be due to imports of new capital machinery that will increase productivity and potential growth.

Assessment June 2011 Question 1, 2, 3, 4