Economics Test - 29

Balance of trade only includes export and import of goods while balance of payments includes all international concepts. So, BoT is a narrower concept as compared to BoP.

Trade deficit and balance of trade deficit are one or the same thing, it is the situation where import of goods exceeds the export of goods during a given period of time.

Uni lateral transfers are one way transactions which have no impact on the assets or liabilities of the country, thus recorded in the current account of BoP.

The given are the examples of export of services, thus considered as invisible trade and recorded in current account of BoP.

Export of goods leads to inflow of foreign exchange while import leads to outflow. In the given situation, as the inflows are greater than outflow, it leads to surplus in BoT.

Surplus is the situation of excess of receipts over expenditures. In BoP, it happens when the balance of credit side exceeds the balance of debit side.

Key Points

• Inflexible exchange rates (also known as floating exchange rates), the exchange rate is determined by the forces of market demand and supply.
  • If the demand for foreign exchange goes up, the domestic currency (rupee) depreciates since it has become less expensive in terms of foreign currency. By contrast, the currency appreciates when it becomes more expensive in terms of foreign currency.
• Interest rate differential is important in determining exchange rate movements.
  • There are huge funds owned by banks, multinational corporations and wealthy individuals who move around the world in search of the highest interest rates.
  • If we assume that government bonds in country A pay 8 percent rate of interest whereas equally safe bonds in country B yield 10 percent, the interest rate differential is 2 percent.
• Investors from country A will be attracted by the high-interest rates in country B and will buy the currency of country B selling their own currency.
• At the same time, investors in country B will also find investing in their own country more attractive and will, therefore, demand less of country A’s currency.
• This means that the demand for country A’s currency will decrease while that of country B's currency will increase.
  • Therefore, country A's currency depreciates whereas that of country B's currency appreciates.
  • Thus, a rise in the interest rates at home often leads to an appreciation of the domestic currency which will increase in the exchange rate of the domestic currency. Hence, statement 1 is correct.
  • If a country's imports grow faster than exports, the capital inflows from exports will not be sufficient to pay for the imports.
    • This will lead to an increase in demand for foreign currency. Therefore the domestic currency depreciates. Hence statement 2 is correct.

Key Points

• Components of Balance of Payments
  • Current account
    1. Trade in goods
       • Imports
       • Exports
    2. Trade in services
    3. Transfer payments
  • Difference between export and import is known as Balance of Trade.
    • ​When imports are lesser than exports, it results in Trade surplus. Hence, statement 1 is correct.
    • When exports are lesser than imports, it results in Trade deficit.
  • Balance of Trade is just a small part of BOP. Therefore, Trade deficit does not mean BOP is always negative. Hence, statement 2 is incorrect.

​Additional Information

• Other components of the BOP
• Capital account
  1. Investments
     • Direct investment
     • Portfolio investment
  2. External Borrowings
  3. External Assistance
• Capital account is in balance when capital inflows (like receipt of loans from abroad, sale of assets or shares in foreign companies) are equal to capital outflows (like repayment of loans, purchase of assets or shares in foreign countries).
• Surplus in capital account arises when capital inflows are greater than capital outflows, whereas deficit in capital account arises when capital inflows are lesser than capital outflows.

The correct answer is Both (A) and (R) are true and (R) is the correct explanation of (A).

Key Points

Goods are cheap in the weekly markets.

• This is because, in weekly markets, the shop owners are helped by their family members.
• These shop owners store the things that they sell at home.
• Weekly markets also have a large number of shops selling the same goods which means there is competition among them.
• Moroever, there are more shops selling the same goods in the weekly market, hence, there is more competition.
• If a trader charges a higher rate, people would move to another shop where the same thing will be available more cheaply or where the buyer can bargain and bring the price down. 

Thus, we can say that both (A) and (R) are true and (R) is the correct explanation of (A).

The correct answer is - a - iii, b - i, c - iv, d - ii

Key Points

• Joint Demand - Tea and Sugar
  • Joint demand refers to two goods that are used together, such as tea and sugar.
  • If the demand for one increases, the demand for the other also rises.
• Joint Supply - Crude Oil and Petroleum Products
  • Joint supply occurs when the production of one good inevitably leads to the production of another, such as crude oil and petroleum products.
  • Crude oil refining produces multiple petroleum products like gasoline, diesel, and kerosene.
• Derived Demand - Computer and Operator
  • Derived demand occurs when the demand for one good arises due to the demand for another related good, such as computers and operators.
  • More computers in offices lead to an increased demand for operators to use them.
• Competitive Demand - Pepsi and Coca-Cola
  • Competitive demand refers to goods that serve as substitutes for each other, such as Pepsi and Coca-Cola.
  • An increase in the price of Pepsi may lead to higher demand for Coca-Cola and vice versa.

Additional Information

• Types of Demand in Economics
  • Joint Demand: When two goods are consumed together (e.g., Cars and Petrol).
  • Competitive Demand: When two goods compete for the same consumer base (e.g., Tea and Coffee).
  • Derived Demand: When the demand for one good depends on another (e.g., Steel and Construction).
  • Composite Demand: When a good has multiple uses (e.g., Milk for Cheese, Butter, and Yogurt).
• Market Demand and Consumer Preferences
  • Consumer preferences determine how demand shifts between complementary and substitute goods.
  • Price elasticity plays a key role in understanding competitive and joint demand.
  • Government policies, taxation, and subsidies also influence demand types.