BBA 1ST SEM/ 1ST YEAAR

MACRO ECONOMICS (BM111)

(UNIT-4)

MEANING
The Balance of Payments is a statement that contains the transactions made by residents of a
particular country with the rest of the world over a specific time period. It is also known as the
balance of international payments and is often abbreviated as BOP. It summarizes all payments
and receipts by firms, individuals, and the government. The statement includes all transaction
information, giving the authorities a clear picture of the money movement. The transactions
can be both factor payments and transfer payments. The balance of payment for a country
reveals whether it has a financial surplus or deficit. It indicates if a country's exports exceed its
imports or vice versa.

DEFINITION

According to Kindle Berger, "The balance of payments of a country is a systematic record of

all economic transactions between the residents of the reporting country and residents of
foreign countries during a given period of time".

It is a double entry system of record of all economic transactions between the residents of the
country and the rest of the world carried out in a specific period of time.
when we say “a country’s balance of payments” we are referring to the transactions of its
citizens and government.

The balance of payments of a country is a systematic record of all economic transactions

between the residents of a country and the rest of the world. It presents a classified record of all
receipts on account of goods exported, services rendered and capital received by residents and
payments made by them on account of goods imported and services received from the capital
transferred to non-residents or foreigners. - Reserve Bank of India

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Importance of Balance of Payment
A BOP is a crucial document or transaction in the finance department since it reveals a
country's and economy's financial position. The following factors can be used to determine the
relevance of BOP:
 BOP records all the transactions that create demand for and supply of a currency.
 Judge economic and financial status of a country in the short-term
 BOP may confirm trend in economy’s international trade and exchange rate of the
currency. This may also indicate change or reversal in the trend.
 This may indicate policy shift of the monetary authority (RBI) of the country.
 BOP may confirm trend in economy’s international trade and exchange rate of the
currency. This may also indicate change or reversal in the trend.
 It analyses all of a country's products and service exports and imports during a specific
time period.
 It assists the government in determining the potential for a certain industry's export
growth and developing policies to encourage such growth.
 It provides the government with a comprehensive view of a variety of import and
export levies. The government then takes steps to raise and lower taxes in order to
discourage imports and boost exports, accordingly, and to achieve self-sufficiency.
 If the economy needs import help, the government will plan according to the BOP, to
divert cash flow and technology to the unfavourable sector of the economy in order to
achieve future growth.
 The government may also use the balance of payments to identify the status of the
economy and plan expansion. The country's monetary and fiscal policies are based on
its balance of payments situation.

Components of Balance of Payment

BOP has the following major components:
 Current Account: This account tracks all products and services that enter and leave
the country. This account is used to cover all payments for raw materials and finished
items. Tourism, engineering, stocks, commercial services, transportation, and royalties
from licenses and copyrights are among the various deliveries mentioned in this
category. All of these factors come together to form a country's BOP.
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The four major components of the Current account are as follows:

Visible trade (Trade in Goods) – This is the net of export and imports of goods (visible
items). The balance of this visible trade is known as the trade balance. There is a trade
deficit when imports are higher than exports and a trade surplus when exports are higher than
imports.

Invisible trade(Trade of services) – This is the net of exports and imports of services
(invisible items). Transactions mainly consist of shipping, IT, banking, and insurance services.

Unilateral transfers to and from abroad – These refer to payments that are not factor
payments – for example, gifts or donations sent to the resident of a country by a non-resident
relative.

Income receipts and payments( Transfer Payment) – These include factor payments and
receipts. These are generally rent on property, interest on capital, and profits on investments.

Capital Account: This account tracks capital transactions such as the acquisition and selling of
non-financial assets such as lands and properties. This account also tracks the flow of taxes, as
well as the purchase and sale of fixed assets by immigrants relocating to a new nation. Finance
from the capital account controls the current account deficiency or surplus, and vice versa.

The three major components of the capital account:

Loans to and borrowings from abroad – These consist of all loans and borrowings given to
or received from abroad. It includes both private sector loans, as well as public sector loans.

Investments to/from abroad – These are investments made by non-residents in shares in the
home country or investment in real estate in any other country.

Changes in foreign exchange reserves – Foreign exchange reserves are maintained by the
central bank to control the exchange rate and ultimately balance the BOP.

 Financial Account: This account records the monies that move to and from other
nations through investments such as real estate, foreign direct investments, business
companies, and so on. This account estimates the foreign owner of domestic assets and
the domestic owner of foreign assets, as well as determining if it is buying or selling
additional assets such as stocks, gold, or equity.
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Disequilibrium In the Balance Of Payments
A disequilibrium in the balance of payment means its condition of Surplus Or deficit
 A Surplus in the BOP occurs when Total Receipts exceeds Total Payments.
Thus, BOP= CREDIT>DEBIT

 A Deficit in the BOP occurs when Total Payments exceeds Total Receipts.
Thus, BOP= CREDIT

Causes of Disequilibrium inthe BOP

 Cyclical fluctuations
 Short fall in the exports
 Economic Development
 Rapid increase in population
 Structural Changes
 Natural Calamites
 International Capital Movements

Measures To Correct Disequilibrium in the BOP

1. Monetary Measures: -
a) Monetary Policy- The monetary policy is concerned with money supply and credit in the
economy. The Central Bank may expand or contract the money supply in the economy through
appropriate measures which will affect the prices.
b) Fiscal Policy- Fiscal policy is government's policy on income and expenditure. Government
incurs development and non - development expenditure, it gets income through taxation and
non - tax sources. Depending upon the situation governments expenditure may be increased or
decreased.
c) Exchange Rate Depreciation -By reducing the value of the domestic currency, government
can correct the disequilibrium in the BOP in the economy. Exchange rate depreciation reduces
the value of home currency in relation to foreign currency. As a result, import becomes costlier
and export becomes cheaper. It also leads to inflationary trends in the country.

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d) Devaluation- Devaluation is lowering the exchange value of the official currency. When a
country devalues its currency, exports become cheaper and imports become expensive which
causes a reduction in the BOP deficit.
e) Deflation- Deflation is the reduction in the quantity of money to reduce prices and incomes.
In the domestic market, when the currency is deflated, there is a decrease in the income of the
people. This puts curb on consumption and government can increase exports and earn more
foreign exchange.
f) Exchange Control-All exporters are directed by the monetary authority to surrender their
foreign exchange earnings, and the total available foreign exchange is rationed among the
licensed importers. The license-holder can import any good but amount if fixed by monetary
authority.

II. Non- Monetary measures: -

 Export Promotion

To control export promotions the country may adopt measures to stimulate exports like:
 export duties may be reduced to boost exports ss
 cash assistance, subsidies can be given to exporters to increase exports
 goods meant for exports can be exempted from all types of taxes.

 Import Substitutes
Steps may be taken to encourage the production of import substitutes. This will save
foreign
exchange in the short run by replacing the use of imports by these import substitutes.
 Import Control
Import may be kept in check through the adoption of a wide variety of measures like quotas
and tariffs. Under the quota system, the government fixes the maximum quantity of goods and
services that can be imported during a particular time period.
1. Quotas – Under the quota system, the government may fix and permit the maximum quantity
or value of a commodity to be imported during a given period. By restricting imports through
the quota system, the deficit is reduced and the balance of payments position is improved.
2. Tariffs – Tariffs are duties (taxes) imposed on imports. When tariffs are imposed, the prices
of imports would increase to the extent of tariff. The increased prices will reduce the demand

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for imported goods and at the same time induce domestic producers to produce more of import
substitutes.
Meaning of Business Cycle
 The Business Cycle refers to the vast Economic fluctuations in trade, production, and
general Economic activities.

 The Business Cycle is also known as the boom-bust Cycle or Economic Cycle.
Business Cycle refers to the up and down movements of the GDP and refers to
widespread expansions and contractions in the level of Economic booming and
activities.

 The Business Cycle graph is never constant.

 The business cycle is the natural expansion and contraction of the production and output of
goods and services that happens over a period of time. It can be said to be the economic rise
and fall of a firm in the economy.

Definition
Prof. Haberler’s – “The business cycle in the general sense may be defined as an alternation
of periods of prosperity and depression of good and bad trade.”

Features of Business Cycle

1. Occurs Periodically: The different phases of a Business Cycle occur from time to
time. Although, at certain times, these periods will vary according to the Economic
conditions of the industry. This duration may last as long as 10-12 years. The intensity
of the phases will also change depending on the Economy. For example, at times, the
firm will see massive growth followed by a short span of depression.

2. Synchronous: Another advantageous and prominent feature of the Business Cycle is

that it is synchronic. The features of a Business Cycle are not restricted to a single firm
or industry. They originate in a free Economy and are prevalent. If there is any kind of
disturbance or Business boom in one industry, it will affect the other firms too. Since

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 different kinds of industries are interrelated, the Business in one firm disturbs that in
another firm.

3. Major Sectors are Affected: It’s been noticed that fluctuations occur not only at the
level of production but also in other variables such as employment, consumption,
investment, rate of interest, and price level. The investment and consumption of durable
consumer goods like houses and cars are continually affected by the periodical
fluctuations. As the process of consumption is deferred the courses of the Business
Cycle are also affected widely.

4. Profit Variation: Another significant feature of the Business Cycle is that the profits
fluctuate more than any other income source. This makes any kind of Business a tricky
and uncertain profession for many. It is difficult to predict Economic conditions. In
situations of depression, profits may even become harmful. That is why many
Businesses go bankrupt.

5. Worldwide Impact: Business Cycles are international in nature. If depression occurs

in one country, then it is bound to spread to other nations too. This happens mainly
because the countries depend on each other for import and export trades. The 1930
depression in the USA and Great Britain shook the entire world and resulted in a
recession.

6. Complex Phenomenon: Business cycles are a very complex and dynamic phenomenon.
They do not have any uniformity. There are no set causes for business cycles as well. So it
is nearly impossible to predict or prepare for these business cycles.

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1. Expansion: When a nation’s GDP shows an upward move or recovers with time, this
period of growth is remarked as economic expansion. During this phase, the
various economic indicators like consumer spending, income, demand, supply,
employment, output, and business returns shoot up.

2. Peak: During the expansion phase, the GDP spikes to its highest level; this is
considered the economy’s peak. At this point, economic factors like income, consumer
spending, and employment level remain constant.

3. Contraction: Next comes the phase of economic slowdown; it occurs when the
stagnant peak GDP starts tumbling down towards the trough. With this, the nation’s
production, employment level, demand, supply, income level, and other economic
parameters plummet.

4. Trough: This is the stage at which the GDP and other economic indicators are at their
lowest. During this phase, the economy gets stuck at a negative growth rate.
Additionally, the demand for goods and services reduces.
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Effects of Business Cycles
Business cycles have both good and bad effects depending upon whether the economy is
passing through a phase of prosperity or depression. In the prosperity phase, “the real income
consumed, real income produced and the level of employment are high or rising and there are
no idle or unemployed workers or very few of either.”
There is general increase in economic activity: aggregate output, demand, employment and
income are at a high level. Prices are rising. Profits are increasing. Stock markets are rapidly
reaching new heights. Investments are increasing with liberal bank credit. This entire process is
cumulative and self-reinforcing.
But different sections of the society are affected differently during the prosperity phase. The
landless, factory and agricultural workers and middle classes suffer because their wages and
salaries are more or less fixed but the prices of commodities rise continuously. They become
more poor.
On the other hand, businessmen, traders, industrialists, real estate holders, speculators,
landlords, shareholders and others with variable incomes gain. Thus the rich become richer and
the poor poorer.
The social effects are also bad. Lured by profit, there is hoarding black-marketing, adulteration,
production of substandard goods, speculation, etc. Corruption spreads in every walk of life.
When the economy is nearing the full employment level of resources, the ill-effects on
production start appearing. Rising prices of raw materials and increase in wages raise costs of
production. As a result, profit margins decline. There is rise in interest rates due to scarcity of
capital which makes investment costly.
These two factors lower business expectations. Lastly, the demand for consumer goods does
not rise due to inflationary rise in prices. This leads to piling up of inventories (stocks) with
producers and traders. Thus sales lag behind production. There is decline is prices. Producers,
businessmen and traders become pessimists and the recession starts.
During recession, profit margins decline further because costs start rising more than prices.
Some firms close down. Others reduce production and try to sell accumulated stocks.
Investment, output, employment, income, demand and prices decline further. This process
becomes cumulative and recession merges into depression.
During a depression, there is mass unemployment. Prices, profits and wages are at their lowest
levels. Demand for goods and services is the minimum. Investment, bank deposits and bank
loans are negligible. Construction of all types of capital goods, buildings, etc. is at a standstill.
There is mass unemployment in the economy. The government revenues from direct and

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indirect taxes decline. The real burden of the debt increases. The economic development of the
country suffers.

Measures to Control Business Cycles or Stabilisation Policies

1. Monetary Policy:
Monetary policy as a method to control business fluctuations is operated by the central bank of
a country. The central bank adopts a number of methods to control the quantity and quality of
credit. To control the expansion of money supply during a boom, it raises its bank rate, sells
securities in the open market, raises the reserve ratio, and adopts a number of selective credit
control measures such as raising margin requirements and regulating consumer credit. Thus the
central bank adopts a dear money policy. Borrowings by business and trade become dearer,
difficult and selective. Efforts are made to control excess money supply in the economy.
To control a recession or depression, the central bank follows an easy or cheap monetary policy
by increasing the reserves of commercial banks. It reduces the bank rate and interest rates of
banks. It buys securities in the open market. It lowers margin requirements on loans and
encourages banks to lend more to consumers, businessmen, traders, etc.
2. Fiscal Policy:
Monetary policy alone is not capable of controlling business cycles. It should, therefore, be
supplemented by compensatory fiscal policy. Fiscal measures are highly effective for
controlling excessive government expenditure, personal consumption expenditure, and private
and public investment during a boom. On the other hand, they help in increasing government
expenditure, personal consumption expenditure and private and public investment during a
depression.The effectiveness of anti-cyclical fiscal policy depends upon proper timing of
policy action and the nature and volume of public works and their planning.
3. Direct Controls:
The aim of direct controls is to ensure proper allocation of resources for the purpose of price
stability. They are meant to affect strategic points of the economy. They affect particular
consumers and producers. They are in the form of rationing licensing, price and wage controls,
export duties, exchange controls, quotas, monopoly control, etc.
They are more effective in overcoming bottlenecks and shortages arising from inflationary
pressures. Their success depends on the existence of an efficient and honest administration.
Otherwise, they lead to black marketing, corruption, long queues, speculation, etc. Therefore,
they should be resorted to only in emergencies like war, crop failures and hyper-inflation.

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