Balance of payments

It is a record of all economic transactions between the individuals, firms, government of a country and the rest of the world in a particular period.
Transactions include exchange of goods and services, income, aid, investment.

Aim of macroeconomics policy – Achieve stability in the balance of payments.

BALANCE OF PAYMENTS
First Section Second Section
 
Current Account Capital and Financial Accounts

Trade in goods 1. Capital Account 2. Financial Account 3. Official Reserves

Trade in services (Reserve Assets)
Investment income It is a relatively small component. It records transactions in assets and liabilities. These are items which are
Current transfers Credit  Direct investment. held to settle debts with
 Funds bought into the country by new  Portfolio investment. other countries.
immigrants.  Other investment. Foreign exchange, special
 Transfer of funds when fixed assets are Credit drawing rights issued by IMF,
acquired. When a foreigner buys asset in the country. reserve position at the IMF,
 Purchase of patents. But these are liabilities as when they generate income and gold.
Debit send it abroad it will be recorded as debit in the current
 Funds sent abroad by people emigrating. account (Investment Income)
 Transfer of funds when fixed assets are Debit
disposed. When citizens buy assets abroad.
 Sales of patents. But these will later generate investment income for the
country which will be recorded as credit in the current
account.
Financial account deficit
A situation where the investment abroad in the year is greater than the foreign investment which has come into the country.

Financial account surplus

A situation where the foreign investment that has come into country is greater than the investment made abroad in the year.

Individuals or firms want to set up in the foreign countries because of

 Lower tax rates
 Lower costs of production
 Expanding markets
 Good factors of production
 Government subsidies.

Individuals or firms may buy foreign shares because

 Profit levels are high
 Dividends are high

Individuals or firms buy foreign government bonds and lend to foreign companies and individuals because of high interest rates

Consequences
1. In the short run, financial account deficit leads to loss of potential jobs and incomes to the foreign economy.
2. In the long run, it may lead to generating income for the country if the investment abroad proves to be profitable.

Current account balance

 Current account surplus
Sum of ①earnings from exports of goods and services ②income received from abroad and ③transfers received from abroad is greater than the sum of ①
expenditures on imports of goods and services ②income paid abroad and ③transfers abroad.

 Current account deficit

Sum of ①expenditures on imports of goods and services ②income paid abroad and ③transfers abroad is greater than the sum of ①earnings from exports of goods
and services ②income received from abroad and ③transfers received from abroad.