NOTES:

THE BASICS ON ABSOLUTE AND COMPARATIVE ADVANTAGE.

ABSOLUTE ADVANTAGE – This is where a country is able to produce more goods and services
compared with other countries using the same quantity of resources. Eg. Let imagine that there are
2 countries. Country Y and country Z, and two (2) products, yam and beans. Now, assume that each
country also has two baskets of resources. One basket in yam production and one basket in bean
production

Country Y produces 10 units of yam and 18 units of beans. With one basket in yam production and
one basket in bean production. Country Z produces 20 units of yam and 8 units of beans. Country Y
has an absolute advantage over country B in the production of beans. Country B has an absolute
advantage over country Y in the production of Yam. This is because, given the same resources,
Country Y can produce more beans than country Z, and country Z can produce more Yams than
country Y. so country Y puts its two baskets of resources into bean production and country Z puts its
two baskets of resources into puts its two baskets of resources into Yam production.

Country Y specializes in the production of beans and country Z specializes in the production of Yams.

Each country can now trade the goods they produce for the goods they do not produce.

NOTE: baskets means the amount of resources used eg. type of labour, land, capital etc.

COMPARATIVE ADVANTAGE – In this theory a country specializes in the production of the good
which it has the least opportunity cost of greatest advantage.

Comparative advantage happens when a country can produce a good at the lowest opportunity cost
when compared with other countries which have the same resources.

OPPORTUNITY COST – The next best alternative forgone. Opportunity costs is where a choice has to
be made. When a choice is made, something else is given up (forgone). Eg. you have $1000, now
you need to make a choice between going to the movies or purchasing a magazine as the $1000
cannot afford you both of these things. If, for example, you choose to go to the movies the
opportunity cost would be the magazine which you gave up in making your choice, and vice versa.

We all have to make choices in our daily lives and so does the government in the operation of the
economy. Eg. the government has to decide on how much/many resources to put into agriculture,
health care, education etc.

BALANCE OF PAYMENTS

When countries trade with each other, a financial account must be prepared usually at the end of
the trading year. The account that sets out this indebtedness between the trading partners is called
a BOP (Balance Of Payment) It is an account that analyses a country’s financial transactions with its
trading partners.

The account has 3 main sections:

1. Current account - this includes:

i. Visible trade – deals with import and export of goods only.
 ii. Invisible trade – examines the imports and exports of services only.

Visible balance is visible exports minus visible imports.

Invisible balance is invisible exports (services) minus invisible imports.

The current account balance is obtained by adding the balance on the visible trade to the invisible
trade.

Balance Of Trade (BOT) is visible exports minus visible imports.

2. Capital account - this looks at the short-term and long-term capital flows (capital coming in
and going out of the country) NOTE: when we talk about money going in and out of a
country/economy, in economics, we refer to this as flows (inflows and outflows).

Outflows are represented by a minus (-) sign beside the figure on the BOT account.

Inflows are represented by a plus (+) sign beside the figure on the BOT account.

The capital account includes a balancing item which represents errors in and omissions from
the account, which may be seen as a (+) or (-)

When the current account balance is added to the Capital Account it gives the BOP
figure/amount.

3. Official Financing – This shows how the BOP is treated. If it is a surplus, it shows how the
government will use this surplus (it shows whether it will be used, saved or spent.

NOTE: A surplus on the BOP account shows that the country has exported more goods
than what it has imported (in money terms) This is a favourable/positive.

If it is a deficit it will indicate how the government was able to finance (find money to cover)
the deficit.

NOTE: A deficit on the BOP account shows that the country has imported more goods than
what it has exported (in money terms) This is considered to be unfavourable/negative. A
BOT deficit is also known as a trade gap.

BOP DEFICIT – Most countries in the Caribbean are face with a deficit on the BOP. This is
due mainly to our dependence on foreign goods. We have been influenced by goods we
receive from family and friends abroad, foreign shows eg. housewives of Atlanta, exposure
to fast foods, eg, KFC; clothing, shoes etc.

There is a high demand in the Caribbean for imported items which may be because of
foreign culture influences (cultural imperialism) and also cultivated foreign tastes over the
years.

This causes an imbalance when we do not have a matching level of exports. Some people
blame the private sector from not finding new markets for their products and move to from
traditional exports. Some blame the government for taking a long time to issue export
license and to getting trading documents issued.
 Devaluation – this can improve trade balances, but it cannot be sustained s we would then
be too dependent on foreign raw materials.

Devaluation worsens trade. It causes goods to be more expensive for consumers, who may
then reduce the amount of goods they would usually purchase, which will then result in
producers having to reduce production levels which in turn will lead to employees being laid
off work. This will add to the unemployment figure causing an increase. The economy will
then experience a sluggish/slow growth.

NOTE: Devaluation – A reduction in the value of a currency in relation to other currencies.

When devaluation takes place exports become cheaper to foreign

customers. Imports become more expensive. Devaluation can cause inflation, and a higher
demand for foreign goods, which now become cheaper.

To Finance BOP Deficit Internally a government can:

a. Use reserves or savings (this is money that the government has been saving over a
period of time for the country to use in the event of eg. natural disasters)
b. Sell the country’s assets eg. historical buildings, industries, land etc. to foreign and or
local buyers.

Financing BOP Deficit Externally a government can:

a. Borrow from financial institutions eg. IMF (International Monetary Fund), World Bank etc.
b. Sell assets
c. Gifts may be used (friendly countries usually give gifts to each other it may be in the form of
money, writing off debts, etc)
d. Accept loans from other countries regionally (in your location eg. Jamaica getting assistance
from Barbados, Trinidad and Tobago etc) and internationally eg. from England, US, China
etc)

Balance of payment Surplus – BOP surplus may be used to:

a. Increase the country’s savings

b. Lend to other countries
c. Pay debts the country owes
d. Invest in commodities locally and internationally
e. Purchase assets eg. businesses from private business owners for the benefit of the citizens.
STRUCTURE OF THE BALANCE OF PAYMENTS

EXAMPLES: stated in US$ millions.

1.

CURRENT ACCOUNT INFLOWS OUTFLOWS NET

Export of goods 13391.30

Import of goods 7669.90

Export of services 923.80

Import of services 377.40

BALANCE OF TRADE +6267.80

Transfers +60.20

Investment income -963.70

CURRENT ACCOUNT BALANCE +5364.30

CAPITAL ACCOUNT

Capital account balance -3468.60

Net errors and omissions -354.60

OFFICIAL FINANCING/OFFICIAL RESERVES

Change in reserves (-increase) -1541.10

+ 0

NOTE: 13391.30 – 7669.90 = 5721.40 (visible goods balance or merchandise balance)

923.80 – 377.40 = 546.40 (invisible services balance or service balance. Services can
include: banking, tourism, insurance, transport and communication)

5721.40 + 546.40 = 6267.80 = BOT

Transfers may include: gifts from private individuals, governments grants etc. an example:
 a niece receives US$100 from her aunt in New York, this will be recorded as an inflow in the
current account of the BOP.

Positive transfer figure mean that inflows exceeded outflows. A negative transfer figure
means that outflows exceeded inflows.

Investment Income can be outflow and inflow. Inflows would be money/incomes received
by individuals in the country who have investment overseas (incomes received from foreign
investments) Outflow is for example, a Jamaican citizens buying shares in an American
company on the New York Stock Exchange (investment by residents or domestic firms in
other countries.

Investment made by foreigners in the country (Jamaica). This is an inflow, as money is

received in the country (Jamaica)

The BOP records ALL the transactions of a country with other countries for one year.

Statisticians depend on information from firms, individuals and government agencies. Some
information/data might not be available at the time of the compilation of the statistics.
There may be errors in recording transactions and the omission of certain transactions. A
value must be placed in the accounts for net error and omissions to account for all the
discrepancies.

Official reserves/financing – this is the government store of foreign currency held by the
central bank of a country. It shows the effect of the flows of payments over the year on the
official reserves of the country. At the end of the year it may be a surplus or a deficit or it
may be in equilibrium (balanced)

On the official financing/reserves if the value is negative it means a surplus on the BOP, if it
is positive it means a deficit on the BOP account. On the BOP Account above, inflows exceed
outflows by US$1541,10 million (Current account balance +$5364.30 minus -$3468.60
minus -$354.60). In order to balance the payments accounts sum zero (0), we need to make
this excess negative. The opposite is done for a deficit.

QUESTIONS: using the above BOP Account:

a. Calculate the merchandise balance

b. Name two services that might be included in the current account.
c. Calculate the services balance
d. What does a negative balance on the capital account mean?
EXAMPLE 2:

BALANCE OF PAYMENT FOR COUNTRY B, 2019 in US$M

CURRENT ACCOUNT

Visible trade

Exports 19 500

Imports 22 300

VISIBLE BALANCE -2 800

Invisible trade (net)

Government -1 030

Shipping +20

Travel +220

Civil aviation +130

Other services +1 230

Interests, profits and dividends +950

Private transfers +90

INVISIBLE BALANCE +1 430

Current account balance -1 370

CAPITAL OR FINANCIAL ACCOUNT

Current balance -1 370

Investment and other capital flows (net) +150

Balancing item +10

Total currency flow -1 210

OFFICIAL FINANCING/RESERVES

Foreign currency borrowing +608

Official reserves of gold and +602

foreign currency +1 210

The total figures show that more was earned from exports in services than imports and the invisible
balance is +$1 430.

The current account is achieved by adding the invisible balance to the visible balance (-$2 800 +(+$1
430 = -$1 370)

The surplus earned from services has reduced the debt on the visible trade from -$2 800 to -$1 370.

This has further reduced the capital account by +$150 million from investments flows and $10
million from the balancing item a total of $160 million.

The balance of payment (BOP), (shown under the Current account balance) that is to be

financed is -$1 210. You will noticed that the government of this particular country used gold and
foreign currency reserves to pay the debt. These are positive figures to show income gained to pay
to trading partners.