Cambridge International as and a level Economics Ebook

Cambridge International AS Level Economics
Consequences of a current account deficit and a 
current account surplus
A current account defi cit allows the residents of a country 
to consume more products than the country produces. 
Th
is is sometimes referred to as a country living beyond 
its means. Th
e country will, however, have to fi nance 
the defi cit by attracting investment into the country or 
borrowing. Th
is will involve an outfl ow of money in the 
future in the form of investment income.
An increase in a current account defi cit may also 
reduce aggregate demand, which may slow down 
economic growth and may cause unemployment.
It might be thought that a current account surplus is 
always benefi cial as it involves a country saving more than 
it is spending. It does, however, mean that the country’s 
residents are not enjoying as high a standard of living 
as possible. Th
e high level of demand, combined with 
additions to the money supply, may generate infl ationary 
pressure. Th
ose countries experiencing current account 
defi cits may also put pressure on the country to change its 
policies in order to reduce its surplus.
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The significance of the size of a current account 
deficit or surplus can be assessed more eff ectively by 
considering it as a percentage of the country’s gross 
domestic product (output) than in monetary terms. For 
example, the USA in 2013 had a current account deficit 
of US$400 billion whereas South Africa’s deficit was only 
US$22 billion. South Africa’s deficit, however, might have 
been more of a concern as it accounted for 6.5% of the 
country’s GDP whereas the USA’s deficit accounted for 
only 2.5% of its GDP.
Definition and measurement of 
exchange rates
Th
e nominal foreign 
exchange rate
is the price of one 
currency in terms of another currency; that is, the price 
of the domestic currency in terms of a foreign currency. 
It is sometimes referred to as a bilateral exchange rate. 
For example, the price of US$1 may be 50 Indian rupees. 
Th
is would mean that a 5,000 rupee product would sell in 
the US for US$100. A rise in India’s foreign exchange rate 
against the US dollar would increase the price of India’s 
exports in terms of US dollars and would lower the price 
of India’s imports in terms of rupees. For example, the 
value of the rupee might rise to US$1 equals 40 rupees 
so that a US dollar may be purchased with fewer rupees. 
Now a 5,000 rupee product would sell in the US for $125. 
A $20 US import that would have initially sold in India for 
1,000 rupees, will now sell in India for 800 rupees.