Wednesday, December 30, 2009

Two-Minute Drill -- Balance of Payments

Summary: Calculating Balance of Payments, Current Account, and Financial Account.

The Acorn Book states that the "Financial Account" will replace the "Capital Account" on this year's exam. This drill is intended to remind students that the Balance of Payments always sums to zero.

My answers are: imports = 1100; financial account balance = 800; BOP = 0 with no statistical discrepancy.

Stress to your students that CA + FA = 0.

Extra Credit: using the spending equation for calculating GDP, can you prove that a current account deficit must mean a financial account surplus?

AP Macroeconomics students seldom have had accounting. I stress that the Balance of Payments is really a system of debits and credits. Exports are a credit (+) and imports are a debit (-) so they offset each other. Likewise, when foreigners buy domestic assets the transaction is a credit (+). Some economists call this a capital inflow. When domestic citizens buy foreign assets including bonds and direct foreign investment, the transaction is a debit (-). This would be a capital outflow.

Some illegal transactions are not captured in the balance of payments and this motivates the need for a statistical discrepancy.

In recent years, the United States has a large current account deficit. Do you think this is a problem?

About the Author: Mike Fladlien is an AP Economics teacher from Muscatine High School in Muscatine, Iowa.


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