Deficits & Surpluses (Cambridge International IGCSE Economics)
Exam board Cambridge International · IGCSEUpdated 2024-06-23
Reasons for Deficits and Surpluses
Spec point —
6.4.2· Reasons for Deficits & Surpluses
- If there is a current account deficit, the value of imports must be greater than the value of exports
- If there is a current account surplus, the value of exports must be greater than the value of imports
Causes of Current Account Deficits
| Relatively low productivity | Relatively high value of the country’s currency | Relatively high rate of inflation |
|---|---|---|
| - Low productivity raises costs - Exporting firms with low productivity may find themselves at a price and cost disadvantage in overseas markets which will decrease competitiveness and the level of exports | - Currency appreciation makes a country's exports more expensive relative to other nations - Foreign buyers look for substitute products which are priced lower - Exports fall and the balance on the current account worsens - Similarly, currency appreciation makes imports cheaper - Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens | - A relatively high rate of inflation makes a country's exports more expensive than other nations - Foreign buyers look for substitute products which are priced lower - Exports fall and the balance on the current account worsens - Similarly, high inflation may mean that goods/services are cheaper in other countries - Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens |
| Rapid economic growth resulting in increased imports | Non-price factors such as poor quality and design | |
| - Rapid economic growth raises household income - Households respond by purchasing goods/services from abroad and the balance on the current account worsens | - When a country develops a reputation for poor quality and design, its exports fall as foreign buyers look for better substitutes elsewhere - Domestic buyers who are able to shop abroad also choose to buy better quality products elsewhere and the level of imports rise |
Causes Of Current Account Surpluses
| Relatively high productivity | Relatively low value of the country’s currency | Relatively low rate of inflation |
|---|---|---|
| - High productivity decreases costs - Exporting firms with high productivity may find themselves at a price and cost advantage in overseas markets which will increase competitiveness and the level of exports | - Currency depreciation makes a country's exports less expensive relative to other nations - Foreign buyers increase their purchases and the level of exports rises - Similarly, currency depreciation makes imports ,ore expensive - Domestic consumers may switch demand to locally produced products and the level of imports falls | - A relatively low rate of inflation makes a country's exports less expensive than other nations - Foreign buyers increase their purchases and the level of exports rises, improving the balance on the current account |
Consequences of Deficits and Surpluses
Spec point —
6.4.2· Impact on GDP, employment, inflation and foreign exchange rate.
- As global trade is a net sum game where the value of global exports = global imports, it follows that if one country is running a current account surplus then another country is running a deficit
- Consequences of current account deficits include
- Increasing unemployment: with falling demand for locally produced goods/services, fewer workers will be required and unemployment will rise
- Slow down in economic growth or a recession: exports are a key component of the real GDP of many countries and a fall in exports may significantly reduce the level of economic growth
- Lower standards of living: a fall in economic growth usually leads to a reduction in wages which leads to a decrease in the standards of living
- Increased levels of borrowing: if the deficit is caused by continually increasing levels of imports, then it is likely that these imports are being paid for through higher levels of borrowing
- Depreciating exchange rate: while this may ultimately help to increase exports again, it makes the cost of imported goods/raw materials more expensive and may cause cost push inflation
- Consequences of current account surpluses include
- Increasing employment: with increasing demand for locally produced goods/services, more workers will be required and unemployment will fall
- Economic growth: exports are a key component of the real GDP of many countries and a rise in exports may significantly increase the level of economic growth
- Higher standards of living: a rise in economic growth usually leads to a rise in wages which leads to an increase in the standards of living
- Demand pull inflation: economic growth caused by a rise in exports will lead to demand pull inflation
- Appreciating exchange rate: rising exports will appreciate the exchange rate which leads to imports now being cheaper which causes the demand for imports to rise
Exam Hint When answering questions on deficits, be absolutely clear if the question refers to a budget deficit or a current account deficit. Students often confuse these two!
A budget deficit refers to the government budget and occurs when the government spending > government tax revenue
A current account deficit occurs when the value of a nation's exports < value of a nation's imports
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