Chapter 8.2 : Balancing International Payments

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  • Created on: 22-03-19 15:49


What are exports?

Exports are goods and services supplied by a country to overseas consumers in other countries.

Exports are an example of cash inflow since it is a source of revenue  earned by the sales of the product overseas.

What are imports?

Imports are goods and services( overseas products) purchased by consumers within a country  from other countries.

Imports are an example of cash outflow since money is leaving the economy and is said to be "leaking" out of an economy.

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Visible trade

What is Visible Trade?

Visible trade is said to be trade on goods . Visible trade involves the trade of physical products hence the name used to describe it.

Visible imports:

Visible imports are goods purchased from overseas that can be physically seen.

Visible Exports:

Visible Exports are goods sold to other countries which can be physically seen.

  • When a country exports more goods than it imports it is said to have a trade surplus which is considered a favourable balance of payments.
  • When a country imports more goods than it exports it is said to have a trade deficit which is an unfavourable balance of payments.

Balance on trade=Visible Exports-Visible Imports

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Invisible trade

What is invisible trade?

Invisible trade is said to be the trade on services hence the name used to describe it. Services are invisible products that can not be physically seen or touched and they are often called intangible products.

Invisible Imports

Invisible imports are services purchased from overseas that can not be seen .

Invisible Exports

Invisible exports are services sold to overseas countries that can not be seen

Balance on services= Invisible Exports- Invisible Imports

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The balance of payments - Part1

  • Current Account
  • Includes:
  • Value of visible trade
  • Value of invisible trade
  • Income recieved by FOPs
    • Debits are:
      • Payments to overseas residents working in the U.S.A
      • Payments of IPD to overseas firms investing in the U.S.A 
    • Credits are:
      • Payments by overseas countries to US residents working there
      • Any IPD earned by investing in overseas firms
  • Income recieved by non-productive activity
    • Debits are:
      • Taxes or excise duties paid by U.S residents overseas
      • Charities ,donations, loans, and financial aid to overseas countries
      • IMF funds to other countries
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The balance of payments - Part 2

  • Capital Account


  • Involves Aquisition and Disposal of land with overseas countries
  • Cancellation of debts
  • Assets transferred by migrants leaving or entering a country and any profits,payments, or inheritance taxes they make
  • Financial Account

1)Bonds and stocks        3)Real estate and reserves of gold and foreign currency
2)Loans                           4) Direct inward investment 

  • Net errors and ommisions

Is a value considered in the balance of payments as a balancing item to the value found at the end

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Exchange Rates

An exchange rate is the market equilibrium price between one currency and another.

Demand for a currency changes as ;

  • Inflation
  • Interest rates
  • Speculation
  • Demand on Goods and Services
  • Inward Investment 


A currency appreciates when the demand on it increases. This means that more people are using the currency and that it's scarcity in the market decreases while its value increases.


A currency deappreciates when the supply of it increases. This means that less people are using the currency as a mean of exchange and therefore it has a lower value.

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Reasons for fluctuations in exchange rate

The following reasons cause fluctuations in the demand and supply of a good or service:

1) Changes in current account balances

If there is a surplus, the value of the currency appreciates against other currencies while if there is a deficit, the value of the currency deappreciates against other currencies

2) Inflation

If inflation occurs, the general prices of products will increase and therefore demand on the currency will decrease since global competitiveness of its exports decrease because of the high prices.

3)Interest rates

If interest rates are high, people from other countries would like to invest in the country and save more .

4) Speculation

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Managed Flotation and Fixed Exchange rate

Note:Whenever an appreciation happens demand by overseas consumers decreases because their currency is deappreciated and its value decreases

Some countries plan to float their currency on two scenarios:

1)High currency value

A high currency value means the country will sell its own currency reserves decreasing its value so  prices increase and consumer demand decreases . Alternatively, they can decrease interest rates to drive off investments from other countries

2) Low currency value  

A low currency value means the currency will buy its own currency increasing its value in the x-change market decreasing prices and increasing consumer demand. Alternatively, they can increase interest rates to increase investment and savings by people from overseas

Fixed Exchange Rate System : A country relies on curbing its currency against another currency

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Correcting a trade imbalance

Ways of correcting a trade imbalance:

  • Do nothing.

If a deficit happens demand on currency will decrease so prices will increases and demand on imports will decrease so currency will redeem value

  • Contractionary fiscal policy

A country may reduce public spending and increase taxes to decrease consumer spending and produce a balance

  • Raise interest rates
  • Introduce trade barriers 
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Problems with Trade Deficit and Surplus

Some problems of TD :

  • Decline in industry
  • Value of currency falls

Some problems of TS:

  • Other countries will exert a pressure on a country to decrease their TS so they can balance their payments
  • Demand push inflation
  • Higher prices and lower demand
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