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O LevelEconomicsCambridge (CIE)Revision Notes6. International Trade & Globalisation6.4 Current Account of Balance of PaymentsDeficits & Surpluses

Deficits & Surpluses (Cambridge (CIE) O Level Economics)

Revision Note

Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Reasons for Deficits and Surpluses

  • If there is a current account deficit, the value of imports must be greater than the value of exports

  • If there is a current account surplus, the value of exports must be greater than the value of imports

 
Causes of Current Account Deficits

Relatively low productivity

Relatively high value of the country’s currency

Relatively high rate of inflation

  • Low productivity raises costs

  • Exporting firms with low productivity may find themselves at a price and cost disadvantage in overseas markets which will decrease competitiveness and the level of exports

  • Currency appreciation makes a country's exports more expensive relative to other nations

  • Foreign buyers look for substitute products which are priced lower

  • Exports fall and the balance on the current account worsens

  • Similarly, currency appreciation makes imports cheaper

  • Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens

  • A relatively high rate of inflation makes a country's exports more expensive than other nations

  • Foreign buyers look for substitute products which are priced lower

  • Exports fall and the balance on the current account worsens

  • Similarly, high inflation may mean that goods/services are cheaper in other countries

  • Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens

Rapid economic growth resulting in increased imports

Non-price factors such as poor quality and design

 

  • Rapid economic growth raises household income

  • Households respond by purchasing goods/services from abroad and the balance on the current account worsens

  • When a country develops a reputation for poor quality and design, its exports fall as foreign buyers look for better substitutes elsewhere

  • Domestic buyers who are able to shop abroad also choose to buy better quality products elsewhere and the level of imports rise

 

 

Causes Of Current Account Surpluses

Relatively high productivity

Relatively low value of the country’s currency

Relatively low rate of inflation

  • High productivity decreases costs

  • Exporting firms with high productivity may find themselves at a price and cost advantage in overseas markets which will increase competitiveness and the level of exports

  • Currency depreciation makes a country's exports less expensive relative to other nations

  • Foreign buyers increase their purchases and the level of exports rises

  • Similarly, currency depreciation makes imports ,ore expensive

  • Domestic consumers may switch demand to locally produced products and the level of imports falls

  • A relatively low rate of inflation makes a country's exports less expensive than other nations

  • Foreign buyers increase their purchases and the level of exports rises, improving the balance on the current account

Consequences of Deficits and Surpluses

  • As global trade is a net sum game where the value of global exports = global imports, it follows that if one country is running a current account surplus then another country is running a deficit

  • Consequences of current account deficits include

  1. Increasing unemployment: with falling demand for locally produced goods/services, fewer workers will be required and unemployment will rise

  2. Slow down in economic growth or a recession: exports are a key component of the real GDP of many countries and a fall in exports may significantly reduce the level of economic growth

  3. Lower standards of living: a fall in economic growth usually leads to a reduction in wages which leads to a decrease in the standards of living

  4. Increased levels of borrowing: if the deficit is caused by continually increasing levels of imports, then it is likely that these imports are being paid for through higher levels of borrowing

  5. Depreciating exchange rate: while this may ultimately help to increase exports again, it makes the cost of imported goods/raw materials more expensive and may cause cost push inflation 

  • Consequences of current account surpluses include

  1. Increasing employment: with increasing demand for locally produced goods/services, more workers will be required and unemployment will fall

  2. Economic growth: exports are a key component of the real GDP of many countries and a rise in exports may significantly increase the level of economic growth

  3. Higher standards of living: a rise in economic growth usually leads to a rise in wages which leads to an increase in the standards of living

  4. Demand pull inflation: economic growth caused by a rise in exports will lead to demand pull inflation

  5. Appreciating exchange rate: rising exports will appreciate the exchange rate which leads to imports now being cheaper which causes the demand for imports to rise

Examiner Tips and Tricks

When answering questions on deficits, be absolutely clear if the question refers to a budget deficit or a current account deficit. Students often confuse these two!

A budget deficit refers to the government budget and occurs when the government spending > government tax revenue

A current account deficit occurs when the value of a nation's exports < value of a nation's imports

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    Author
    Reviewer
    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

    Jenna Quinn

    Author: Jenna Quinn

    Expertise: Head of New Subjects

    Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.