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AP Macro: Unit 7. Balance of Payments. Balance of Payments. In a closed economy, economists keep track of transactions with the national income account (GDP). In an open economy, (with international trade) they keep track with the “balance of payments accounts.”. The Balance of Payments
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AP Macro: Unit 7 Balance of Payments
Balance of Payments In a closed economy, economists keep track of transactions with the national income account (GDP). In an open economy, (with international trade) they keep track with the “balance of payments accounts.”
The Balance of Payments • A nation's balance of payments is the sum of all transactions that take place between its residents and the residents of all foreign nations A summary of a country’s transactions with other countries-
Example: The Ryan family farm • $100,000 revenue from selling rhubarb • Spent $110,000 on purchase of machinery, buying food, paying bills, etc. • Received $500 in interest on bank account, but paid $10,000 interest on mortgage • Took out a $25,000 loan for farm improvements
The Ryan Financial Year • Cash: spent $110,000; made $100,000 Net -$10,000 • Interest: spent $10,000; made $500 Net -$9,500 • Loans/Deposits: borrowed $25,000; deposited $5,500 after covering losses Net $19,500 • Balance $0
Balance of Payments • When a U.S. resident sells a good, such as wheat, to a foreigner, that’s the end of the transaction. • But a financial asset, such as a bond, is different. That sale creates a liability in the future. • The balance of payments accounts distinguish between transactions that create liabilities and those that don’t.
Current Account Current account: It is a section in a nation's international balance of payments that is made up of 1. Exports and imports of currently produced goods and services • US Exports: credit-earn foreign currencies (inpayments to US) • US Imports: debit- reduce stock of foreign currencies (outpayments from US) 2. Net investment income 3. Nets transfers Example: • A Chinese company sells $1 million worth of berets to the U.S. army. • BMW pays $1 million to a U.S. shipper for transporting cars from Germany to the United States.
Financial Account • Transactions that involve the sale or purchase of assets, and therefore create future liabilities, are part of the financial account (we used to call this the capital account) Measures the difference between 1) The inflows of foreign money for the purchase of real and financial assets (stocks, bonds) at home and 2) The outflows of currency for the purchase of foreign assets abroad. With account surplus, they buy assets instead of storing assets. Example: • Andre Prenoor, U.S. entrepreneur, invests $50 million to develop a theme part in Malaysia. • An investor buys five $10,000 treasury bonds.
Current / Financial Account • General Rule: Current Account + Financial Account = 0 • The sources of cash must equal the uses of cash • Remember the circular flow: one person’s (or country’s) expenses are another person’s (or country’s) income
Payments to the rest of the world for assets Payments to the rest of the world for G&S (negative component of U.S. current acct) Rest of World United States Payments to the United States for G&S (positive component of U.S. current acct) Payments to the United States for assets
Review Q: The current account plus the financial account is equal to: • Zero • One • The trade balance • The size of the trade deficit • Sorry, I’ve been napping.
Financial Account • Measures capital inflows from foreign savings that become available for domestic investment • How do you think the effect the market for loanable funds?
2008 #2 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 )? - THURSDAY
Rubric 2008 #2 6 points (2 + 2 + 2) • 2 points: • One point is earned for stating that the transaction will be recorded in the current account. • 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:
