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Question: A country has a deficit on the current account of its balance of payments. Discuss whether this is necessarily harmful to the country? May/Jun 2005, I try my best to answer this question. Warning: Please do not believe what i have written here! Its up to you!

One of the component for the balance of payments is Current Account. Under Current account its include Visible balance, Invisible Balance, Services and Transfers. A deficit on the current account means there is a huge amount of outflow of money than inflow. Does this may lead to a harmful to a country? Well, its depends!

First, we look at Visible balance, I prefer to call it BoT ( Balance of trade ) I get used to call it at school. What do we understand about BoT? Export Revenue - Import Spending = BoT or Price of Export x Quantity of Export Minus Proce of Import x Quantity of Import, It just same. What can bring the BoP to deficit in relation to BoT? I have many possibilities here:

Case 1

The question asked, is it harmful to a country? In this case, I'd like to say Yes! Why? Automatically we know that BoT has worsen due to Import Spending is higher than Export Revenue. Assume the Price of Export goes up, and the price of import has fallen, this can affect the demand of the good, so PED (Price Elasticity Demand) involved. If the Px goes Up, and the Pm fallen, and the PED for both X and M ( X- Export, M - Import ) is elastic, I'm sure the BoT will be worsen!

Case 2

Same situation from case 1 but what if both PED for X and M is inelastic, Does this can bring improvemnet to BoT? Yes! Price goes Up but demand for X decrease less than proportionate, so X Revenue Increases, same goes to M, Pm fallen, demand increase less than proportionate, as a result import spending has fallen, when X revenue is greater than import spending, we call that the BoT has improved!


I think my answer is not fully completed, but I have another work to do, hope if I have a free time, I'll continue later. Again, if there's anything wrong with my answer, please raise it up!