Eduqas A Level Economics
Eduqas A Level Economics The Balance of Payments Exam Questions
Free Eduqas A Level Economics revision for The Balance of Payments: what you need to know, common mistakes and exam-style questions with answers. Covers current and financial accounts, causes of current account imbalances, the terms of trade, impacts and corrective policies.
Practise The Balance of Payments with past papers
Once you have learnt this topic, find the The Balance of Payments questions in real Eduqas A Level Economics past papers and mark them with the mark scheme. Doing lots of real questions is the quickest way to learn how examiners ask about each idea.
About Eduqas A Level Economics The Balance of Payments
The balance of payments is a macroeconomic objective in the Eduqas specification. You need to understand that the balance of payments records all transactions between the UK and the rest of the world and that, overall, it sums to zero, so a current account deficit is matched by inflows on the capital and financial accounts. You analyse the causes of current account imbalances, including productivity, relative costs, exchange rates and industrial structure, explain the terms of trade and calculate a terms of trade index, and evaluate the impacts of persistent deficits and the policies used to correct them. Links to exchange rates, trade and growth make it a frequent Component 3 essay theme.
What you need to know
- Structure The current account records trade in goods and services, primary income (e.g. investment income) and secondary income (transfers). The financial account records flows of investment such as FDI and portfolio investment. Detailed knowledge of sub-accounts is not needed.
- Balancing The balance of payments always balances overall. A current account deficit must be financed by a net inflow on the financial account, for example foreign investors buying UK assets.
- Causes of imbalances Current account deficits can come from low productivity, high relative costs, a strong exchange rate, rapid growth of consumer spending, a weak manufacturing base, commodity prices and protectionism abroad. A structural deficit persists even when the economy is at trend output.
- Terms of trade Terms of trade index = (index of export prices / index of import prices) x 100. An improvement means each unit of exports buys more imports, but it may reduce competitiveness.
- Impacts of a deficit A persistent deficit may reduce AD and jobs in export industries, lead to selling off domestic assets, depend on confidence of foreign investors and put downward pressure on the exchange rate. A deficit financed by FDI is less risky than one financed by short term flows.
- Solutions Expenditure switching policies (depreciation, protectionism) and expenditure reducing policies (deflationary fiscal or monetary policy) work in the short run. Supply side policies that raise productivity and competitiveness are the long run solution.
Common mistakes in The Balance of Payments
- Saying the UK has a balance of payments deficit. The overall balance of payments always balances; the deficit is on the current account.
- Treating a current account deficit as always a problem. It depends on its size relative to GDP, how it is financed and whether it reflects investment or consumption.
- Inverting the terms of trade formula. Export prices go on top: (export price index / import price index) x 100.
- Assuming depreciation improves the current account immediately. The Marshall-Lerner condition must hold, and in the short run demand is often inelastic.
Try three The Balance of Payments exam-style questions
1. Export prices index is 108 and import prices index is 120. Calculate the terms of trade index and state whether the terms of trade have improved or worsened from a base of 100. (2 marks)
Show the mark scheme answer
108 / 120 x 100 = 90; the terms of trade have worsened (deteriorated).
2. Explain why a current account deficit must be matched by a surplus elsewhere on the balance of payments. (3 marks)
Show the mark scheme answer
A deficit means more money flows out for imports than comes in from exports; this must be financed; by a net inflow on the financial or capital account, such as foreign purchases of UK assets or borrowing from abroad, so the total sums to zero.
3. Evaluate the use of supply side policies to reduce a current account deficit. (10 marks)
Show the mark scheme answer
A strong answer would explain how training, infrastructure and investment raise productivity and lower unit costs, improving price and non-price competitiveness and exports; evaluate long time lags, cost to government, uncertain effectiveness and that deficits may reflect strong domestic demand; compare with expenditure switching and reducing policies and reach a judgement.
The Balance of Payments FAQs
What does Eduqas A Level Economics The Balance of Payments cover?
It covers the current and financial accounts, why the balance of payments balances overall, causes of current account imbalances, the terms of trade, the impacts of persistent deficits and policies to correct them.
Which component is The Balance of Payments examined in?
It can appear in Components 1 and 2, often with trade data, and it is used in both the Macroeconomics and Trade and Development sections of Component 3.
What should I know about the UK current account?
The UK has run a current account deficit for many years, mainly from a large trade in goods deficit partly offset by a surplus in services, especially financial services. Use this context in your answers.
