Economics Chapter 8 Balance of Payments Class 12 short question / long question
Q.1) Distinguish between Balance of Trade and Balance of Payments.
Difference between balance of trade and balance of payment.
Balance of trade represents the difference between visible exports and imports of a country. Balance of payments represents invisible items included in addition to visible items.
Balance of Payments includes the following items.
1. Export and Import of Commodities: Every country exports some goods and imports some goods. By exporting goods it becomes a creditor country on the other hand by importing goods it becomes a debtor country.
2. Cost of Transportation: Cost of transportation has to pay for export and import of goods. If export and import trade are carried in foreign shipping then the country is a debtor country in respect of this item.
3. Interest on Capital lent Abroad: Rich and wealthy countries lend their capital to needy countries. The debtor countries have to pay interest on borrowed capital.
4. Banker’s Commission: Banks working in foreign countries earn commission and foreign countries stand as debtors to the countries to which the banks belong.
5. Expenses of Tourists: Foreigners may visit a country for tourism. They spent money in that country where they go for tourism. Such expenses may increase the value of import or export.
6. Foreign Education: When a student goes abroad for higher studies then he spends a lot of money in that country which increases the value of import or export.
7. Political Expenses: For payment of diplomatic services a country spends money in foreign country. Such expenses must be included in the calculating indebtedness. In view of Meade visible and invisible exports and imports are regarded as trade items on the other hand the loans and grants which are taken or given to different countries are regarded as transfer items. The difference of trade items is called the balance of trade. But when transfer items are included in a trade item, it is called balance of payment.
Q.2) Define the term ‘Balance of Payments’ and explain the information recorded in it.
Financial account of foreign trade of a country is called balance of payments.
In international trade, two types of transactions take place. On the one hand, goods or services are exported and foreign exchange is earned. And on other hand, goods or services are imported and foreign exchange is spent. Similarly, capital movements in the form of loans, grants or direct foreign investment also take place between countries. An annual accounting statement of these transactions of goods and capital is presented through balance of payments.
The balance of payments is a comprehensive record of economic transactions of a country with the rest of the world during a particular year.
The balance of payments is prepared in such a way that a complete and meaningful picture is obtained about the value, quantity and direction of trade of goods, services and capital. A study of balance of payments would reveal whether a country is exporting enough to cover its import bill or whether it is managing imports through loans from other nations. Balance of payments acts as a helpful guide for the government to formulate its internal and external economic policies. In the light of the position of balance of payments, the government can make changes in monetary, fiscal and commercial policies. Balance of payments of a country is called deficit when the value of its experts is less than the value of its imports.
Balance of Payments
Balance of payment is a wider term than balance of trade. The letter is only a part of balance of payments which includes balance on visible items, balance on invisible items and balance on account of capital movements.
Balance of payments = Balance of visible items + Balance of invisible items.
(Balance of trade)
The balance of payments accounts of a country is subdivided into three accounts.
1) Current Account.
2) Capital Account.
3) Financial Account. (or Monetary Account)
1) Current Account. The balance on current accounts relates only to current transactions of goods and services. It includes trade balance of visible exports and imports as well as the services (invisible items). The balance of payments on current accounts is said to balance when the total of credit items (of exports) just equals the total of debit items (of imports).
2) Capital Account. In this account, the movements of capital in or out of the country are recorded. For example, if Pakistan gets a loan from the USA, it will be recorded as a plus (credit) item in our capital account. If a Pakistani invests in Dubai. It is like our imports where foreign exchange is used. Capital account is divided into two parts – Short period account and long period account.
3) Financial Account (Monetary Account). It includes foreign direct investment and long term loans.
Q.3) What are the causes of disequilibrium in the balance of payments of a country ?
The balance of payments of a country is not always in equilibrium. It may show a deficit or surplus. There are three parts of balance of payments; current account, capital account and monetary account. Current account shows receipts and payments of foreign exchange through normal and routine trading of goods and services. When the receipts and payments in this account are not equal, it is called disequilibrium of balance of payments. If the total amount of foreign exchange earned by a country during a year is more than the total payments to other countries, the balance of payments of a country is surplus and favorable. When the foreign receipts are less than the payments, the balance of payments is deficit and unfavorable. If a country has an unfavorable balance continuously for many years, it will either be in danger of losing foreign exchange reserves or will be increasing its foreign debts. Pakistan is facing this problem.
The CAUSES of disequilibrium (deficit) in balance of payments are the following.
A. Fall in Exports
Exports may fall because of:
1) Inflation causes the price of exportable commodities to rise. Foreign demand for goods falls. Consequently less foreign exchange is earned.
2) Decrease in production of exportable items may decrease due to depression, war, floods, drought or strikes etc.
3) Technological advancement may help other countries to develop cheap substitutes of the commodity exported by a country. For example, during the past two or three decades, synthetic fibers have replaced cotton in many uses and prices of cotton products have not risen enough.
4) Depression in other countries lowers their demand for our imports.
5) Trade Restrictions Sometimes other countries impose heavy custom duties or fix quotas or ban imports from a country. It results in lower exports of that country.
B. Rise in Imports
Imports may rise because of:
1) Rapid increase in population will require more and more quantity of food and consumer goods. If the home production is insufficient, it will have to import.
2) Economic development when economic development is going on fast, the country needs more and more machinery, equipment and materials.
3) Invisible Imports A country may be spending huge amounts on invisible imports (services) in the form of insurance, banking, travel and education abroad and frequent foreign tours of government leaders.
C. Unfavorable Terms of Trade
Unfavorable terms of trade means that prices of imports are increasing faster than prices of exports. A country may export more quantity of goods, but due to adverse terms of trade difference between value of exports and imports may increase.
Q.4) How does an adverse Balance of Payments arise? How can it be corrected?
Since balance of payments becomes adverse because of excess imports over exports, a country having such a problem must try to check imports either by total prohibition or by levying import duties so by a quota system. Another method may be import substitution i.e. trying to produce in the country what it currently imports. Exports can be stimulated by measures of export promotion granting subsidies or other concessions to industrialists and exports.
Methods for correcting adverse balance of payments
1. Improving Balance Of Trade
The most important part of balance of payments is usually the balance of trade. So steps are taken to make it favorable. For this purpose, exports are encouraged and imports are reduced.
Exports can be increased by:
a. Reducing exports duties.
b. Granting concessions to exports industries as lower taxes, cheaper loans etc.
c. Decreasing prices of exports items to make these cheaper for foreigners.
d. Devaluation of currency so that our goods become cheaper for others.
e. Improving quality of exports products to make them competitive in international markets.
f. Increasing production of exportable goods.
Imports can be reduced through:
a. Increasing imports duties on unnecessary items and
b. Fixing quotas for certain commodities and giving protection to local industries.
c. Banning the import of luxury items.
d. Establishing import substitution industries to produce substitutes of imports.
2. Invisible-Exports and Imports. A country can increase invisible exports of services like tourism, exporting labor or exporting software programs. On the other hand foreign exchange can be saved by reducing invisible imports.
3. Exchange Control. To make best use of limited foreign exchange, the governments have been using exchange control. Exporters are required to surrender the foreign exchange earned to the central bank. The central bank, then, decides how to use it. Pakistan applied exchange control during 60’s and 70’s
4. Borrowing from the International Monetary Fund. The International Monetary Fund can also help in the correction of the balance of payments. It gives short term loans to member countries to bring them out of trouble
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