How do you calculate Balance of Payments? (1 Viewer)

[buddyhield]

It's from Topic 2 - Australia's place in the global economy

 

[BenHowe]

Hey,

Ok first things first you need to be able able understand what the balance of payments actually is, the two main categories and their individual components. I say this because sure you might get an mcq question on calculating an actual component but sometimes you can get a question such as ,explain the relationship between the current account and the capital and financial account, which requires an certain level of understanding. Don't worry though I think this topic is the hardest in eco.

Anyways first things first the balance of payments is just a record of all financial transactions of an economy over a given period of time. In the balance of payments there are two main accounts, the current account (CA) and the capital and financial account (KAFA). The CA is a record of the movement of funds within the economy i.e. debits and credits such as debt repayments or dividends respectively. The KAFA is a record of all the investment and capital flows within an economy over a given period of time. Here's a picture sorry about the handwriting

Net goods – difference between goods exported (+) and goods imported (-)
Net services – difference between services exported (+) and services imported (-)
Net primary income – sum of payments for factors of production, inflows or credits (+) and outflows or debits (-)
Net secondary income – one way transfers of money i.e. remittances or aid (only if the aid is not used to increase a countries capacity otherwise it is in the capital acc.)

Capital account – capital transfers such as tied aid and non-produced and non-financial assets such as intellectual property
Direct investment – purchasing more than 10% of an existing business or establishing a business
Portfolio investment – buying of land, shares and other marketable securities in existing companies, less than 10%
Financial derivatives (or sometimes referred to as futures) – a contract which allows a transaction to take place at a fixed price in the future i.e. QANTAS buying a contract which allows them to buy jet fuel at today’s prices in the future etc.
Reserve assets – assets that are controlled by central authorities for financing and regulating payment imbalances such as the RBA selling AUD in forex market to improve liquidity prior to FDI etc. These include monetary gold, special drawing rights and currency
Other investment – transactions not classified in the categories above. Examples include trade credits, loans including financial leases, currency and deposits.

Remember since in reality its difficult to keep track of the transactions occurring within an economy with a floating exchange rate such as Australia, net errors and omissions are introduced to ensure the sum of the BoP is always equal to 0.



Anyways if we ignore the categories of the BoP for the moment and consider for a moment the Australian economy but specifically the market for Australian dollars to US for arguments sake. In this market since the AUD has been 'floated' (ignoring the RBA occasionally 'dirtying the float' to increase liquidity for FDI) supply=demand. But remember that supply represents all those who are willing and able to sell AUD so predominantly the private sector or households, whereas demand represents all those who wish to buy AUD predominantly o/s. So here's the assumption, that since S=D that any given inflow must = any given outflow and therefore any sufficient deficit in one account i.e. CAD, will be offset by a surplus in the other i.e. KAFAS. Therefore CA+KAFA=0 noting net errors and omissions.

That equations forms the basis for your calculation concerning the balance of payments. Sorry about the lengthy explanation, it's important you understand it because sometimes in exams they try to fk you up. For example in the 2010 HSC exam:

The table shows selected data for an economy.
Balance of Payments items $ billion ($bn)
Exports 500
Imports 540
Net services −70
Net income −115
Net current transfers 85
Capital transfers 30
Reserve Assets −20
According to the information in the table, which statement is correct for the economy if
it has a floating exchange rate?
(A) There is a deficit of $225bn on the balance of goods and services.
(B) There is a surplus of $140bn on the capital and financial account.
(C) There is a surplus of $950bn on the current account.
(D) There is a deficit of $10bn on the capital account.
hsc
So you just normally go through and sum together the amounts in the CA and KAFA and find the unknown but the trick here is that you know for the CA that the imports must always be an outflow since the funds recieved for the goods in hat transaction are leaving Aus and going O/S. Hence you need to make it negative i.e. -540 etc.

Thus the sum of the CA=500-540-70-115+85=-140 and since it has a floating exchange rate CA+KAFA=0 therefore -140+KAFA=0 therefore KAFA=140 i.e. answer B.

Other questions make you make you find the value of an individual component rather than the CA or KAFA ( I couldn't be bothered finding one)

If you have any questions please ask, am a bit rusty since havent done eco since HSC exam. Hope this helps.

 

[buddyhield]

wow thanks for the help. i'm starting to get a better understanding. but with the hsc multi choice question how do you know what information to include in your calculation?

because i assume you have to use different information from the table to calculate the balance of goods and services, capital and financial account, capital account and financial account.

thanks again i really appreciate it

 

[BenHowe]

Find a question and I'll explain it

 

[buddyhield]

Find a question and I'll explain it

sorry for the late reply

 

[BenHowe]

Ok this isnt too bad but there are a few tricks.

First off you gotta realise exports/imports are just net goods. Secondly you need to make sure imports are negative since imports result in a debit being recorded on the CA since an outflow of funds (remember CA is a record of the flows of money).

Then it's fairly straightforward. Since floating exchange rate the formula CA+KAFA=0 applies, but for all BoP questions you can just assume this. So for the CA:E-700+100-150+50=E-700.
KAFA:200

Therefore E-700+200=0, thus E=500 $bn noting units i.e. C

Make sense?

 

[luo_ge]

Ok this isnt too bad but there are a few tricks.

First off you gotta realise exports/imports are just net goods. Secondly you need to make sure imports are negative since imports result in a debit being recorded on the CA since an outflow of funds (remember CA is a record of the flows of money).

Then it's fairly straightforward. Since floating exchange rate the formula CA+KAFA=0 applies, but for all BoP questions you can just assume this. So for the CA:E-700+100-150+50=E-700.
KAFA:200

Therefore E-700+200=0, thus E=500 $bn noting units i.e. C

Make sense?

thanks i think i get it now. so when given a table u just substitute everything in (regardless of positive or negative) in the formula. (except for imports - which is always negative?)

 

[BenHowe]

Yeah just make sure you think about what you're doing and not just mindlessly do stuff.

The other equation u need to know/be able to calculate stuff with is net foreign liabilities.

Net foreign liability=net foreign debt+net foreign equity

Has proved v useful for some mcq's

 

[luo_ge]

Yeah just make sure you think about what you're doing and not just mindlessly do stuff.

The other equation u need to know/be able to calculate stuff with is net foreign liabilities.

Net foreign liability=net foreign debt+net foreign equity

Has proved v useful for some mcq's

thanks

 

[ivan99]

Bop = O DONT BE STUPID