Ch2010 - CHAPTER 10 BALANCE OF PAYMENTS MEANING AND...

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B ALANCE OF P AYMENTS : M EANING AND C OMPONENTS C HAPTER 10 The Balance of Payment (BOP) Accounts are an important aspect of the study of macro economy. In our four sector circular flow diagram given in Chapter 2, it has been shown that the external sector influences the working of an open economy. Macroeconomic phenomena cannot be confined with a particular economy. On the other hand, open economies react sharply to events that are occurring in the rest of world sector. In order to record the overseas transactions of a country, the BOP accounts are maintained and they constitute an important part of the national income accounts. The BOP accounts are a summary of international transaction of a country for a given period, that is a financial year. ‘The balance of payments of a country is a systematic record of all economic transactions between the residents of the reporting country and the residents of foreign countries during a given period of time’ 1 . Here, are two questions that need to be answered. They are: who is a resident? What is a economic transaction? Resident of a country ordinarily includes individuals, business units, government and their agencies. An economic transaction is an exchange of value: a process in which “there is transfer of title to an economic good, the rendering of an economic service from residents of one country to residents of other countries. 2 Relation between National Income and Balance of Payments Economic activity usually generates two types of transactions that give rise to international payments and receipts. Firstly, activities arising from production and sale of current output and secondly, those arising from the purchase and sale of existing assets, both real and financial. Let us consider the first, which is production and sale of current output. In an open economy, the expenditure of consumers, investors and government in addition to the expenditure of foreigners on the country’s exports 1 International Economics, Charles P. Kindleberger Homeward, Illinois, Irwin, p. 457. 2 ibid
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I NTRODUCTORY M ACROECONOMICS 140 generates the nation’s production of goods and services. The income generated by this can be shown in the following expression: Y = C + I + G + X This income is disposed off in the purchase of consumer goods and services (C), savings (S) and taxes (T). Add the goods and services purchased from abroad by the domestic sectors, that is imports (M). Following expression gives the way income is disposed off: Y = C + S + T + M According to national income accounting, income generated must be equal to income disposed off. Therefore, C + I + G + X = C + S + T + M Simplifying this we obtain I + X + G = S + T + M Here I, G and X are injections into the income stream and S, T and M are leakages there from. So, in equilibrium planned injections must be equal to total planned leakages. Balance of Trade and Balance of
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Ch2010 - CHAPTER 10 BALANCE OF PAYMENTS MEANING AND...

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