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 ChangesDiscuss 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• 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 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.

Current Account AD/AS Model

AS

A

PRICE LEVEL

REAL GDP

AD

AD1

AD2

P2

P1

P

B C

• 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.

Current Account AD/AS Model

AS

A

PRICE LEVEL

REAL GDP

AD

AD1

AD2

P2

P1

P

B C

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

Does a deficit balance matter?

• 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 For

• 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.

Argument Against

• June 2011

• Question 1, 2, 3, 4

Assessment