Answers to End of Chapter Questions
Chapter 1
Keeping Up With a Changing World-Trade Flows, Capital Flows, and the Balance Of Payments
1. The balance on merchandise trade is the difference between exports of goods, 719 and the
imports of goods, 1,145, for a deficit of 426. The balance on goods, services and income is 719 + 279 +284 – 1145 - 210 – 269, for a deficit of 342. Adding unilateral transfers to this gives a current account deficit of 391, [-342 + (-49) = -391]. (Note that income receipts are credits and income payments are debits.)
2. Because the current account balance is a deficit of 391, then without a statistical
discrepancy, the capital account is a surplus of 391. In this problem, however, the statistical discrepancy is recorded as a positive amount (credit) of 11. Hence, the sum of the debits in the balance of payments must exceed the credits by 11. So, the deficit of the current account must be greater than the surplus on the capital account by 11. The capital account, therefore, is a surplus of 391 – 11 = 380.
3. A balance-of-payments equilibrium is when the debits and credits in the current account and
the private capital account sum to zero. In the problem above we do not know the private capital account balance. We cannot say, therefore, whether this country is experiencing
a balance-of-payments surplus or deficit or if it is in equilibrium.
4 The current account is a deficit of $541,830 and the private capital account balance is a
surplus of $369,068. The U.S., therefore, has a balance of payments deficit.
5 Positive aspects of being a net debtor include the possibility of financing domestic
investment that is not possible through domestic savings; thereby allowing for domestic capital stock growth which may allow job, productivity, and income growth. Negative aspects include the fact that foreign savings may be used to finance domestic consumption rather than domestic savings; which will compromise the growth suggested above.
Positive aspects of being a net creditor include the ownership of foreign assets which can represent an income flows to the crediting country. Further, the net creditor position also implies a net exporting position. A negative aspect of being a net creditor includes the fact that foreign investment may substitute for domestic investment.
6 A nation may desire to receive both portfolio and direct investment due to the type of
investment each represents. Portfolio investment is a financial investment while direct investment is dominated by the purchase of actual, real, productive assets. To the extent that a country can benefit by each type of investment, it will desire both types of investment.
Further, portfolio investment tends to be short-run in nature, while FDI tends to be long-run in nature. This is also addressed in much greater detail in Chapter 7.
7. Domestic Savings - Domestic Investment = Current Account Balance
Domestic Savings - Domestic Investment = Net Capital Flows
Therefore, Current Account Balance = Net Capital Flows
8 Using the equations above, private savings of 5 percent of income, government savings of
-1 percent, and investment expenditures of 10 percent would results in a current account deficit of 6 percent of income and a capital account surplus (net capital inflows) of 6 percent of income. This could be corrected with a reduction in the government deficit (to a surplus) and/or an increase in private savings.
Chapter 2
