4.1.7 Balance of payments Quiz: Pearson Edexcel Economics A, Unit 4

The 20 questions

1. Which of the following is recorded in the current account of the balance of payments?

   • Net trade in goods and services, together with net primary and secondary income flows
   • Loans from foreign banks to domestic households for the purchase of homes and other property
   • Purchases of shares in foreign companies by domestic investors, which are recorded as portfolio investment
   • Changes in the central bank's holdings of foreign exchange reserves over the year

2. Which item belongs in the capital and financial account of the balance of payments?

   • Payments received by a government from the EU, recorded as secondary income transfers
   • Income earned by domestic residents from overseas employment, recorded as primary income
   • Exports of cars sold to buyers in other countries over the course of the year
   • Foreign direct investment, such as a multinational building a new factory in the host country

3. A country's current account is in deficit. What is the most likely cause?

   • Strong export demand from overseas that exceeds the country's ability to supply goods to the world
   • High domestic saving that is held in foreign currency deposits rather than domestic bank accounts
   • Large inflows of foreign direct investment that raise the value of domestic assets for foreign owners
   • Strong domestic demand for imports combined with weak export competitiveness

4. Exports of goods are £200bn and imports of goods are £230bn. Services exports are £80bn and services imports are £60bn. Net primary income is -£10bn and net secondary income is +£5bn. What is the current account balance?

   • +£20bn, since the services surplus of £20bn is larger than all the other items combined in the year
   • -£15bn, since the goods deficit (-30), services surplus (+20), primary (-10) and secondary (+5) sum to -15
   • -£10bn, since net trade in goods and services alone is -10 and income flows are not counted at all
   • -£30bn, since only the goods deficit of £30bn determines the current account balance in any year

5. Which of these measures is most likely to reduce a current account deficit caused by excess domestic demand for imports?

   • A fall in interest rates, which encourages households to borrow and spend more on imported goods
   • An expansionary fiscal policy that raises government spending and so increases household incomes further
   • A rise in the inflation rate, which raises import prices and so reduces demand for imported goods
   • A contractionary fiscal or monetary policy that reduces domestic income and so the demand for imports

6. Which supply-side measure could help a country reduce a persistent current account deficit over the long run?

   • Higher wage growth unrelated to productivity, which raises household incomes and so export demand
   • Investment in education and infrastructure that improves productivity and the quality of exports
   • A permanent increase in import tariffs, which the WTO always endorses as a long-run solution to deficits
   • A cut in productivity-enhancing spending on training, which lowers the cost of the government budget

7. Why might a current account deficit not be a serious concern for an economy?

   • If it leads to a continuing fall in the exchange rate and rising imported inflation for many years
   • If it is financed by short-term speculative capital flows that can leave the economy in a matter of weeks
   • If it is financed by long-term foreign direct investment into productive capacity that raises future exports
   • If it reflects a large and persistent government budget deficit that is funded by central bank borrowing

8. A country runs a current account deficit of £20bn. Under double-entry accounting, what must be true of the financial and capital account, ignoring errors and omissions?

   • It must show a net inflow of £20bn only if the government has agreed to borrow from the IMF that year
   • It must show a net inflow of about £20bn, so that the overall balance of payments sums to zero
   • It must be in balance with no net flows at all, because the current account is the only account that matters
   • It must show a net outflow of about £40bn, so that the overall balance of payments is in deficit by £20bn

9. Why are large global trade imbalances considered significant?

   • They make all currencies identical in value, which eliminates the need for exchange rate policy in every nation
   • They can lead to unsustainable borrowing and build-up of debt, increasing the risk of sudden adjustments in exchange rates
   • They ensure that all countries hold the same level of foreign exchange reserves, which stabilises the world economy
   • They guarantee faster global growth in every country, since surplus and deficit nations trade more with each other

10. A country runs a current account deficit, financed by a financial account surplus. Which statement is most accurate?

    • The financial account surplus means the country must be exporting more goods than it imports overall
    • The deficit is caused by a financial account surplus, so the two are never linked to each other in practice
    • The financial account surplus is recorded as income, so it is not related to the current account balance at all
    • The deficit is matched by net inflows of capital or reserve changes, so the surplus finances the imports

11. Which is a reason why a current account surplus may be a problem for a country?

    • It always leads to the currency falling in value, which makes all imports more expensive for consumers
    • It always causes inflation to rise sharply, which harms all households in the country regardless of income
    • It may reflect weak domestic demand, and it can build up reserves at the cost of foregone domestic consumption
    • It always means that the country is failing to export enough goods to its trading partners in the world market

12. Which measure would most directly reduce a current account deficit through a change in relative prices?

    • A rise in the domestic price of all goods, which makes exports more attractive to all foreign buyers
    • A depreciation of the currency, which makes exports cheaper and imports more expensive for domestic buyers
    • A cut in import tariffs, which lowers import prices and so makes imports relatively cheaper for domestic buyers
    • An appreciation of the currency, which makes exports cheaper for foreign buyers and imports cheaper for domestic buyers

13. Which best describes the financial account of the balance of payments?

    • Flows of capital, including FDI, portfolio investment, bank lending and changes in official reserves
    • The government's budget position, measured as the difference between tax revenue and public spending
    • Income from overseas employment and remittances, which are recorded as secondary income in the accounts
    • Trade in physical goods only, such as manufactured products, raw materials and agricultural commodities

14. Which measure is an example of protectionism used to reduce a current account deficit?

    • A rise in the exchange rate, which makes imports cheaper and so raises the volume of imports
    • A tariff on imported manufactured goods, which reduces imports but may invite retaliation from trading partners
    • A subsidy to all domestic exporters that is paid for by a tariff on imports from the same trading partners
    • A cut in the cost of imports, which raises the number of imports that households can afford to buy

15. Which of these would be most likely to worsen a country's current account balance in the short run?

    • A rise in tariffs on imported goods that reduces the volume of imports entering the country
    • A rise in domestic income that increases spending on imported goods and services
    • A fall in domestic income that reduces spending on imported goods and services across the economy
    • A depreciation of the currency that makes its exports cheaper for foreign buyers in every market

16. Which of the following items would be recorded as secondary income in the current account?

    • Interest paid by domestic firms on loans taken out from foreign banks in the year
    • Profits earned by a domestic subsidiary of a foreign company and remitted to its parent company
    • Purchases of government bonds by foreign investors, which are recorded as a portfolio inflow
    • Remittances sent home by migrant workers and transfers paid to or from international organisations

17. Which of the following is a measure of the global significance of persistent surpluses in some countries?

    • They have no effect on other countries, because current account balances are only important within each country
    • They mean that the surplus countries are always net importers of capital from deficit countries in every year
    • They may accumulate large foreign exchange reserves, which can be invested abroad and affect global capital flows
    • They always reduce the reserves of the surplus countries to zero, which makes them dependent on international loans

18. A country's government spends heavily on imports financed by borrowing from abroad. Which is the most likely long-run risk?

    • Falling imports, because borrowing from abroad always reduces the demand for imported goods in the economy
    • A permanent improvement in the terms of trade, since foreign borrowing always raises the price of exports
    • Rising export earnings that automatically finance the debt, so the country never faces any risk from foreign borrowing
    • Rising external debt that must be serviced, which can reduce future income and make the economy vulnerable to shocks

19. Which statement best evaluates a policy of reducing a current account deficit by cutting domestic demand?

    • It always improves growth and employment, because lower imports release resources for new domestic investment
    • It has no effect on imports, because imports depend only on exchange rates and not on domestic income
    • It always removes the deficit in the short run without any effect on output or unemployment in the economy
    • It can reduce imports, but it may also lower growth and raise unemployment, so the trade-off must be weighed

20. Which factor is most likely to cause a rise in the current account deficit of a country that imports much of its energy?

    • An increase in the country's energy exports to foreign buyers, which automatically worsens its current account
    • A rise in world oil prices, which raises the value of its imports relative to the value of its exports
    • A fall in the country's own domestic demand for energy, which raises the value of its imports overall
    • A fall in world oil prices, which raises the value of its energy imports and so worsens the current account

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