Balance of Payments (B.O.P) 1 SS3 Economics Lesson Note

SPECIFIC OBJECTIVES: At the end of the lesson, pupils should be able to

1. Define balance of trade and balance of payment
2. State the parts of the balance of payment
3. Discuss the terms of trade and how to finance the deficit balance of payment
4. Explain the devaluation of currency and its effects
5. Outline the conditions in which devaluation can improve a country’s balance of payment

INSTRUCTIONAL TECHNIQUES: 

• Identification, 
• explanation, 
• questions and answers, 
• demonstration, 
• videos from source

INSTRUCTIONAL MATERIALS: 

• Videos, 
• loudspeaker, 
• textbook, 
• pictures

NOTE

BALANCE OF TRADE

This is the comparison of a country’s total visible exports with her total visible imports.  When visible exports with her total visible imports in monetary terms are equal we have a Balance of Trade. 

A positive or favourable Balance of Trade – means that a country is exporting more in monetary terms than it is importing while a negative or unfavourable balance of trade means that a country is importing more in monetary terms than it is exporting.

BALANCE OF PAYMENT

Balance of payment may be defined as a statement or record showing the relationship between a country’s total payments to other countries and its total receipts from them in a year.  A country’s Balance of payment is grouped into three parts.

1. Current Account
2. Capital Account
3. Monetary movement Account
4. Current Account: The Current Account is made up of receipts and payments for visible and invisible services.  The visible comprises tangible products such as cars, computers, clothing materials, electronics etc. While the invisible services are: insurance, banking, transport, interest payment and tourism.
5. Capital Account: For a country to set up business in other countries, and for other countries to set up business in its country, there is a need for inflow and outflow of capital both in the long and short term; this is contained in the capital account.  This is in the form of investments, loans and grants.
6. Monetary Movement Account: There is a need for differences in the Current account and Capital Account to be settled.  This is done in the monetary movement Account.

 TERMS OF TRADE

The term of trade is the rate at which a country’s export is exchanged for its import.  It is expressed as a relationship between the prices a country receives for its exports and the prices it pays for imports.

         Terms of Trade (TOT) = Index of import price   x   100

                                                 ___________________________________

                                             Index of import price            1 

The terms of Trade are favourable if the average price of exports is higher than the average price of imports. The terms of Trade are unfavourable if the average import price is higher than the average export price, which results in more expensive imports than exports and this situation makes the Terms of trade deteriorate.  When the Terms of Trade are unfavourable, the index is less than 100.  This will reduce the real national income.

The Balance of payment of a country can either be favourable or unfavourable, in most cases, it could be balanced.  A country’s Balance of payment is said to be favourable when the receipts from invisible and visible export trade becomes greater than payment to other countries on invisible and visibleimports.  A credit balance can be used to increase investment or to add to a country’s gold reserve. 

On the other hand, an unfavourable balance of payment is said to occur when the payments on visible and invisible imports are greater than receipts on visible and invisible exports.  This is also known as adverse or deficit balance.

 HOW TO FINANCE DEFICIT BALANCE OF PAYMENT

Different Options opened to a country seeking to correct her adverse balance of payment.  The following options could be considered;

1. A country can borrow from foreign financial institutions e.g. World Bank, Paris Club.
2. Assistance could be sought from international financial institutions
3. Foreign investment could be disposed of to offset the debt (if any).
4. Gold could be exported (if any).
5. The national economy could be deflated through monetary and fiscal measures.
6. Import substitution – This could be in the form of curtailment of imports and export stimulation.
7. The country’s currency could be devalued, which would encourage exports and discourage imports.
8. Gifts and aid from friendly countries can be used to settle the indebtedness.
9. The interest rates can be raised to encourage the inflow of foreign capital.
10. Export promotion.

DEVALUATION OF CURRENCY

A country’s devaluation of currency is a deliberate policy through which the value of one country’s currency is reduced about another country’s currency.  It can also be defined as a fall in the exchange value of a country’s currency to the currencies of other countries.

EFFECTS OF DEVALUATION OF CURRENCY

1. The exports of the country whose currency is devalued become cheaper.
2. As a reverse to the above, the import too becomes expensive.
3. Since the exports become cheaper, more would be sold abroad.
4. Balance of payment improvement – as said earlier, when more are sold abroad, foreign exchange accruing to the nation can be used to improve the Bop of the nation.
5. There is an increase in the number of industries which will lead to an increase in employment.

CONDITIONS IN WHICH DEVALUATION CAN IMPROVE A COUNTRY’S BALANCE OF PAYMENT

1. The imports demand must be elastic.  An increase in prices of imports, as a result of devaluation, will lead to a fall in demand for imports.
2. The country’s exports must be elastic i.e. It should be able to respond to foreign demand.
3. Other countries must not devalue their currencies.
4. There must be no increase in wages and other incomes.

MATHEMATICAL APPROACH TO CURRENCY DEVALUATION

The rate at which a country exchanges its currency for other countries’ currencies is known as the “Exchange rate”.

Example I

Assuming that Nigeria is willing to buy or sell cocoa at N800 per ton and the USA is willing to buy or sell at $100, then the value of the two currencies can be fixed as ………..

N800  =  $100

N8  =  $1

Example II

If the exchange rate of naira to a dollar is as follows:

If Nigeria devalues her Currency by 100%, the new exchange will be …. If formerly

N100  =  $1

=   100   x   100   =  N100

  100   x 1

N100  +N100  =  N200

Hence   N500  =   $.50

 EVALUATION

1. Write a short note on (a) Balance of trade.     (b)Balance of payment.
2. Suggest any five ways a country can finance a Deficit Balance of Payment.
3. Distinguish between favourable and unfavourable Balance of Payment
4. State five effects of currency devaluation.
5. Illustrate how currency devaluation can help to correct adverse balance of payment

CLASSWORK: As in evaluation

CONCLUSION: The teacher commends the students positively