In UK, balance of payments always deficit nowadays. This essay will investigate the relation of balance of payments and what UK government can do to improve the balance of payment. Firstly, this essay will talk about the definition of balance of payments, what the meaning of balance of payments has been in deficit and how to improve balance of payment. Balance of payments is a record of all recorded financial transactions between the UK and the rest of the world in a particular financial year.
Balance of payments deficit means the current account is negative which means import is more than export or capital outflow is more than inflow. This essay would like to give a definition of import and export. Import means trade in goods plus services. And export means sale goods and services to another counties. Capital outflow or inflow is the investment income different beyond countries. Balance of payments is current account plus capital account. Current account different must be equal to capital account different because the accounting procedure. (Problems of Balance of Payments Disequilibria, 2006)
Moreover, consumption and services supply is not enough to cope with local demand. Therefore, import value maybe high while demand for foreign goods in another country . That may makes balance of payments deficit. Besides, because of local production cost increasing makes other countries need to buy expensive good or services. Thus, export value will be low. However, because of export value is low and need to buy foreign goods. Thus, there is a deficit. There are the same at increase the cost of buying UK goods for services. Therefore, the export value maybe very low.
But the export value is unchanged then current account maybe deficit. (Balance of payments, 2007) Furthermore, this is a method to solve the deficit of balance of payments. It needs to improve balance of payments. Balance of payments does not mean the current account or net capital flow are positive or in surplus. It maybe decrease in deficit, the deficit of both account. Besides, net export increase government can restrict import. The meaning by restrict impost is government controls the import of certain goods from other countries and use some quota or import tax o reduce import value.
If add to import tax, then price will increase, quantity will decrease. If elasticity bigger then 1, import value will decrease. If import value decrease, then net export value will climb back. (UK trade deficit narrows due to surprise increase in exports, 2011) Also, net capital flow can make balance of payment climb back and add capital inflow or reduce the capital outflow. To solve net capital flow method is restrict capital flow. It means do not allow UK people invest overseas and attract foreigner invest in UK. Then, net capital flow will increase international trade.
Secondly, this essay will talk about the theory of comparative advantage in international trade. Comparative advantage is mean a country product a good with lower opportunity cost than other countries. For examples, Country A produce Good X and Good Y, respectively need to use 2 units resources and 4 units resources. And Country B product Good X and Good Y, respectively need to use 3 units resources and 5 units resources. The opportunity cost of Country A produce Good Y is 2X and the opportunity cost of Country B produce good is 1. 6667X and 1Y.
Therefore, the comparative advantage of producing Good Y is on Country B. In the same way, if UK specialize in produce some goods in comparative advantage, the production cost will be lower relatively. Therefore, export value may increase, net export value will increase. Finally, balance of payments will improve. (Comparative advantage – Definition, 2007) Thirdly, this essay will define the economic problem and demonstrate the understanding of issues relating to resource usage and scarcity. Scarcity means that some goods at zero price then the quantity demanded is larger than quantity supplied.
That is scarcity. Under scarcity, people will minimize costs. If people trade goods internationally and specialize in production. Then, we will enjoy the comparative advantage and produce more quantity of goods. Thus, when scarcity exist international trade may occur. (Scarcity definition, 2008) In addition, this essay will explain how exchange rates are determined and distinguish between different types of exchange rate system. There are two type of exchange rate systems I would like to talk in this essay.
They are floating exchange rate system and fixed exchange rate. In floating exchange rate system, balance of payments will adjust automatically. For example, demand of UK goods increase, the demand for pounds will increase because foreigner need to exchange their currency to get pounds for buying UK goods. Therefore, exchange rate of pounds will increase and the cost of buying UK goods will increase. Finally, export value will decrease. Thus, the exchange value will adjust the net export value and the balance of payments. Currency Exchange Rates Define Market Behavior in Fore, 2011) Moreover, there are one more example for floating exchange rate system. For example, USA goods demand increase, demand for US dollars will increase, then the exchange rate of US dollars will increase. People need to exchange US dollars by UK pounds. Therefore, pounds supply will increase, The exchange rate of pounds will decrease. Thus, UK people buy less USA goods. It is because the cost of buying USA goods become higher than before. Then, balance of payments deficit will improve. (Floating Exchange Rate, 2012)
In fixed exchange rate, balance of payments will not adjust automatically because UK will maintain the exchange rate at a certain so exchange rate will be remain unchanged. Finally, balance of payments cannot be improve. Floating exchange rate system can solve the deficit, but fixed unless UK abandon the fixed exchange rate system. (Currency Exchange: Floating Rate Vs. Fixed Rate, 2012) To conclude, balance of payments have a relationship between comparative advantage, scarcity and exchange rate. All of these things will affect balance of payments imports and exports. Therefore, it will affect balance of payments deficit or surplus.
