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

Revision Note

Author

Steve Vorster

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Economics & Business Subject Lead

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

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

Increasing employment: with increasing demand for locally produced goods/services, more workers will be required and unemployment will fall
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
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
Demand pull inflation: economic growth caused by a rise in exports will lead to demand pull inflation
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

Exam Tip

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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