AQA GCSE Economics: Balance of payments and distribution of income (8136) – Revision Notes

These notes condense sections 3.2.2.5 Balance of payments and 3.2.2.6 Distribution of income of the AQA GCSE Economics (8136) specification for first teaching from September 2017. The specification has no tiers. Exchange rates, which affect the current account, are in the international trade and exchange rates revision notes. Progressive and regressive taxes are in the UK government revenue and tax revision notes. Course links: AQA GCSE Economics hub, checklist and free diagnostics. Worked-example figures are invented.

Part A: Balance of payments (3.2.2.5)

Key terms

Term	Meaning
Balance of payments	A record of all money flows between a country and the rest of the world over a year
Current account	The part of the balance of payments covering trade in goods and services plus income flows
Balance of trade	Exports minus imports of goods and services (some books use it for goods only, so check the question)
Primary income	Income from abroad, mainly profits, interest and dividends on investments, and wages
Secondary income	Transfers with nothing traded in return, such as foreign aid and money sent home by migrants
Current account surplus	More money flows in than out on the current account
Current account deficit	More money flows out than in on the current account

Money coming in (exports, income from abroad) is a credit (+). Money going out (imports, income paid abroad) is a debit (−).

Building the current account (£bn)

Item	Credits	Debits	Balance
Trade in goods	380	560	−180
Trade in services	330	210	+120
Balance of trade			−60
Primary income			−15
Secondary income			−20
Current account			−95

• Trade balance = −180 + 120 = −60.
• Current account = −60 − 15 − 20 = −95, a deficit of £95bn.
• As a share of GDP of £2,500bn: 95 ÷ 2,500 × 100 = 3.8% of GDP. Using a share of GDP lets you compare years and countries of different size.

UK pattern. The UK has had a current account deficit for many years. It usually has a large deficit on trade in goods, partly offset by a surplus on trade in services, especially financial and business services.

Reasons for a current account deficit or surplus

Deficit more likely when	Surplus more likely when
Incomes at home grow quickly, so imports rise	Demand at home is weak, so fewer imports are bought
The pound is strong: exports dear abroad, imports cheap	The currency is weak: exports cheap abroad
Domestic firms are less productive or prices rise faster than abroad	Firms are competitive on price and quality
Trading partners are in recession, so they buy fewer exports	Trading partners are growing fast
The country lacks key resources (such as fuel) and must import them	The country has resources others want, such as oil

Significance

• A deficit must be financed, by borrowing from abroad or by selling assets to foreign buyers.
• Spending on imports is income for foreign firms, so a deficit can mean fewer jobs in UK firms that export or compete with imports.
• A deficit matters less if it is small, short-lived, or caused by importing machinery that will raise future output.
• A surplus brings income and jobs from exports, but one country’s surplus is another’s deficit, and a big surplus may mean people at home consume less than they could.

Government policies to influence the balance of payments

• Reduce demand at home (higher taxes, lower spending, higher interest rates), so fewer imports are bought. Conflict: slower growth and more unemployment.
• Supply-side policies (training, investment, lower business taxes) to make firms more competitive. These take a long time.
• A lower exchange rate makes exports cheaper abroad and imports dearer, though it can raise inflation.
• Tariffs and quotas on imports. Other countries may retaliate, and they may break trade agreements.

Exam traps (balance of payments)

• The balance of payments is about flows with the rest of the world. It is not the government’s budget, and a current account deficit is not the same as a budget deficit.
• Get the signs right: imports and income paid abroad are negative.
• A falling deficit (from −95 to −60) is still a deficit.

Part B: Distribution of income (3.2.2.6)

Key terms

Term	Meaning
Income	A flow of money received over a period: wages, profits, interest, rent, benefits and pensions
Wealth	A stock of assets owned at a point in time: property, savings, shares, pension funds
Income inequality	Differences in the incomes of individuals or households
Wealth inequality	Differences in the wealth people own
Redistribution	Government action that moves income or wealth from richer to poorer households
Original income	Income before taxes and benefits
Disposable income	Income after direct taxes are paid and cash benefits received

The distribution of income in the UK

• The ONS ranks households from poorest to richest and splits them into five equal groups (quintiles) or ten (deciles).
• Before taxes and benefits, the richest fifth of UK households has an original income many times that of the poorest fifth. After taxes, cash benefits and services such as the NHS and schools, the gap is much narrower.
• Wealth is far more unequal than income in the UK, because property, shares and pension savings build up over a lifetime and can be inherited.

Worked example: quintile shares. In Country R the five quintiles receive 7%, 12%, 17%, 23% and 41% of total income (total 100%). The richest 20% get 41 ÷ 7 = about 5.9 times the share of the poorest 20%. With perfect equality each quintile would get 20%.

Worked example: redistribution. Household S earns £15,000, pays £1,000 in tax and receives £4,000 in benefits, so disposable income is £18,000. Household T earns £90,000 and pays £25,000 in tax, so disposable income is £65,000. Before: 90,000 ÷ 15,000 = 6 times. After: 65,000 ÷ 18,000 = about 3.6 times. Taxes and benefits narrowed the gap.

Causes of inequality

• Differences in skills, education and qualifications, and so in wages (see the labour market notes on wage differentials).
• Type of job, hours worked, and part-time or insecure work.
• Unemployment, illness, disability or caring responsibilities.
• Age: earnings usually rise through a career, and many pensioners have low incomes.
• Discrimination by gender, ethnicity or disability.
• Inheritance and ownership of property and shares, which earn rent, dividends and capital gains.
• Regional differences: average pay is higher in London and the South East.
• The tax and benefit system itself, depending on how progressive it is.

Consequences of inequality

Possible costs	Possible benefits
Poverty, poorer health and lower life expectancy for low-income groups	The chance of higher pay gives people an incentive to train, work hard and start businesses
Less equal chances in education and later life	Rewards risk-taking and enterprise
Social tension and possibly more crime
Higher government spending on benefits

Government policies to redistribute, and their consequences

Policy	How it redistributes	Possible drawbacks
Progressive income tax	Higher earners pay a larger share of income	May weaken incentives to work or encourage avoidance
Inheritance tax, capital gains tax	Taxes wealth and its growth	Unpopular; the wealthy may avoid it
Benefits (such as Universal Credit) and the State Pension	Raise the incomes of poorer households	Cost; benefits that are withdrawn as earnings rise can reduce the reward for working more
Free public services (NHS, state schools)	Give everyone services whatever their income	Paid for through taxes, so taxes are higher
National Minimum Wage and National Living Wage	Raise the pay of the lowest-paid workers	Firms’ costs rise, which may cost some jobs

Redistribution can conflict with growth if it weakens incentives, and fairness is a value judgement: economists can show who gains and loses, but how much equality is right is a matter of opinion.

Exam traps (distribution)

• Income is a flow; wealth is a stock. Do not mix them up.
• Inequality is about the gap between groups; poverty is about having too little. A country can reduce poverty while inequality rises.
• Taxes and spending both redistribute. Mention both when asked how redistribution is achieved.

Quick self-test

1. What is the current account of the balance of payments?
2. Goods: exports 250, imports 310. Services: exports 140, imports 90. Find the balance of trade.
3. Add primary income +12 and secondary income −18 to your answer to Q2. Find the current account balance.
4. Give two reasons a country might have a current account deficit.
5. Why might a current account deficit be a problem?
6. Distinguish between income and wealth.
7. Give three causes of income inequality.
8. Household X earns £20,000, pays £2,000 tax and receives £3,000 in benefits. Find its disposable income.
9. Name two government policies that redistribute income.
10. Give one argument that some inequality can be good for an economy.

Answers

1. The record of trade in goods and services and income flows between a country and the rest of the world.
2. Goods −60, services +50, so the balance of trade is −10 (a deficit).
3. −10 + 12 − 18 = −16, a current account deficit of 16.
4. Any two: fast-growing incomes at home, a strong currency, low productivity or high inflation compared with competitors, recession in trading partners, lack of key resources.
5. It must be financed by borrowing or selling assets, and it can mean fewer jobs in exporting and import-competing firms.
6. Income is a flow of money over a period; wealth is a stock of assets owned at a point in time.
7. Any three: differences in skills and education, type of job, unemployment, age, discrimination, inheritance, ownership of property and shares, region.
8. 20,000 − 2,000 + 3,000 = £18,000.
9. Any two: progressive income tax, benefits, the State Pension, free public services, the minimum wage, inheritance tax.
10. The prospect of higher income gives people an incentive to work, train and start businesses.

Where marks are usually lost

• Confusing a current account deficit with a government budget deficit.
• Sign errors when adding up the current account.
• Treating wealth and income as the same thing.
• Naming a redistribution policy without saying how it changes the gap, or what the drawback is.

Frequently asked questions

What is the difference between primary and secondary income? Primary income is income from abroad, mainly profits, interest and dividends on investments, and wages. Secondary income is transfers with nothing traded in return, such as foreign aid and money sent home by migrants.

What is disposable income? Disposable income is income after direct taxes are paid and cash benefits are received.

How can the government reduce a current account deficit? By reducing demand at home, using supply-side policies to make firms more competitive, allowing a lower exchange rate, or using tariffs and quotas, each with drawbacks.

Is a current account deficit the same as a government budget deficit? No. The current account records flows with the rest of the world, while a budget deficit is when government spending exceeds its revenue.

What is the difference between inequality and poverty? Inequality is about the gap between groups; poverty is about having too little. A country can reduce one without reducing the other.

Official syllabus

AQA GCSE Economics (8136) specification, for first teaching from September 2017 (Version 1.0), published by AQA: sections 3.2.2.5 Balance of payments and 3.2.2.6 Distribution of income.