Cambridge O Level Economics: Current account of the balance of payments (2281) – Revision Notes

These notes condense all four outcomes of section 6.4 of the Cambridge O Level Economics 2281 syllabus for examination in 2026. For full explanations and longer worked examples read the study guide, then test yourself with the practice set. All countries and figures are invented for illustration. Money is in millions of an imaginary currency, the zel, unless stated. Useful links: the Cambridge O Level Economics hub, the checklist and the free diagnostics.

6.4.1 Structure and calculations

Current account: a country’s yearly record of trade in goods and services plus income and gift flows with other countries. A balance is money in minus money out.

Component	In (credit)	Out (debit)
Trade in goods	Goods exported	Goods imported
Trade in services	Services sold abroad (for example foreign tourists)	Services bought from abroad
Primary income	Wages, interest, profit, dividends earned abroad	The same paid to foreigners
Secondary income	Gifts, aid, remittances received	Gifts, aid, remittances sent

Formula	Use
Component balance = money in - money out	Each line
Current account balance = sum of the four component balances	Overall
Balance on goods and services = goods balance + services balance	Trade balance
Balance ÷ GDP × 100	Size relative to the economy

Method in steps

1. Work out each component’s balance with its sign.
2. Add the four balances.
3. Positive means surplus; negative means deficit. State which.
4. To compare with the size of the economy, divide the balance by GDP and multiply by 100.
5. For a missing component, subtract the known balances from the total.

Worked reminder

Country V, one illustrative year: goods in 310, out 275; services in 60, out 85; primary income in 18, out 40; secondary income in 30, out 12. Balances: +35, -25, -22, +18. Total: 35 - 25 - 22 + 18 = +6, a small surplus. Goods and services alone: 35 - 25 = +10. With GDP of 480, the surplus is 6 ÷ 480 × 100 = 1.25% of GDP.

6.4.2 Causes

Deficit	Surplus
Home prices climb faster than rivals’	Goods that sell well: lower prices or better quality
High exchange rate	Low exchange rate
Rising incomes pull in imports	High saving, low spending on imports
Exports are a few primary products with falling prices	Valuable raw material or energy exports
Profits and interest paid to foreign owners and lenders	Income earned on overseas assets
Recession abroad cuts demand for exports	Strong growth among trading partners
Remittances, gifts or aid sent abroad	Remittances or aid received

Competitiveness reminder: if home prices rise 8% and a rival’s rise 5%, the relative price is 1.08 ÷ 1.05 = 1.0286, so home goods are about 2.9% dearer than before.

6.4.3 Consequences

Area	Deficit	Surplus
GDP	Net exports fall; demand leaks abroad; GDP lower than it would be	Net exports rise; demand and GDP higher
Employment	Job losses where firms lose sales to imports	More jobs in export industries
Inflation	Lower demand eases pressure; but a falling currency raises import prices	More demand may cause demand-pull inflation if capacity is nearly full
Exchange rate	Floating: more currency supplied than demanded, so it falls. Fixed: reserves run down	Floating: more demand for the currency, so it rises. Reserves build up

Chain for a deficit (practise writing it): imports exceed exports, so net exports fall, so total demand for home output falls, so output and jobs fall. If the currency then falls, imports cost more, so cost-push inflation may follow.

A deficit is not always harmful. It matters less if it is small relative to GDP, is temporary, or pays for machinery that raises future output. It matters more if it is large, lasts for years, and pays for consumption.

Reserves sum: years of cover = reserves ÷ annual deficit. Reserves of 90 and a deficit of 15 a year give 90 ÷ 15 = 6 years.

Exchange rate, PED and trade (6.3.4 link)

Worked reminder: the zel rises from 1 zel = 2.00 marn to 1 zel = 2.50 marn. A jacket priced at 100 zel goes from 200 to 250 marn, a rise of 25%. A machine priced at 300 marn goes from 150 to 120 zel, a fall of 20%.

If PED for exports is 0.5, quantity falls 0.5 × 25 = 12.5%. Revenue in marn: 1.25 × 0.875 = 1.094, up about 9.4%. Revenue in zel: price unchanged, quantity down 12.5%, so down 12.5%. The home exporter earns fewer zel even though the foreign-currency total rose.

Rule: with elastic demand, cutting the price lifts revenue. With inelastic demand, cutting it lowers revenue, while raising it lifts revenue.

6.4.4 Policies

Policy	Mechanism	Strength	Weakness
Deflationary fiscal (higher taxes, lower spending)	Cuts incomes and import spending	Can act fairly fast	Lower growth and jobs
Higher interest rates	Cuts borrowing and spending	May attract foreign savings	Raises firms’ costs
Tariffs and quotas	Make imports dearer or scarcer	Direct effect on imports	Retaliation, higher prices, small effect if PED is low
Subsidies	Lower costs of exporters or import-competing firms	Helps targeted industries	Costs government money
Lower exchange rate	Cheaper exports, dearer imports	Boosts export demand	Depends on PED; higher import costs
Supply-side (training, infrastructure, research)	Raises productivity and quality	Tackles the cause	Slow, uncertain

Worked reminder (tariff): imports of 500 units at 40 zel with a 15% tariff cost buyers 40 × 1.15 = 46 zel each. If PED is 0.4, quantity falls 0.4 × 15 = 6%, to 470. Payments to foreign sellers fall from 20,000 to 470 × 40 = 18,800, a saving of 1,200. The tariff revenue (470 × 6 = 2,820) goes to the government.

Conflicts to mention (syllabus 4.2.2): economic growth against balance of payments stability, and full employment against balance of payments stability. Policies that cut a deficit by cutting demand work against both aims.

Evaluation checklist: cause of the deficit, size, PED, time lags, retaliation, side effects, then a judgement.

Must-know distinctions

• Current account vs trade balance. The trade balance is goods and services only.
• Primary vs secondary income. Primary income is earned from work or ownership abroad. Secondary income is a gift with nothing received in return.
• Deficit vs debt. A deficit is a yearly flow. Debt is an accumulated stock.
• Depreciation under floating vs devaluation under fixed. The market causes the first. The government or central bank chooses the second.
• Tariff vs quota. A tariff taxes imports; a quota limits quantity.

Quick self-test

1. Name the component that records profit paid by a foreign-owned factory to its overseas owners.
2. Name the component that records money spent by foreign tourists.
3. Calculate the current account balance: goods +45, services -60, primary income +12, secondary income -8.
4. An economy with GDP of 900 has a deficit of 18. What share of GDP is that?
5. The current account is +20. Goods are +50, services -30, primary income -12. Find the secondary income balance.
6. State the relative price change if home prices rise 8% and a rival’s rise 5%.
7. At 1 zel = 2.00 marn, convert 500 marn to zel. Repeat at 1 zel = 2.50 marn.
8. Reserves are 90 and the deficit is 15 a year. How many years can reserves cover it?
9. A 15% tariff is placed on an import priced at 40 zel. What do buyers pay?
10. Export prices abroad fall 10% and PED is 1.6. Find the change in quantity and in revenue in the foreign currency.
11. State one weakness of using deflationary policy to cut a deficit.

Answers

1. Primary income (an outflow).
2. Trade in services (an inflow).
3. 45 - 60 + 12 - 8 = -11, a deficit.
4. 18 ÷ 900 × 100 = 2.0%.
5. Known: 50 - 30 - 12 = 8. Secondary income = 20 - 8 = +12.
6. 1.08 ÷ 1.05 = 1.0286, about 2.9% dearer.
7. 500 ÷ 2.00 = 250 zel; 500 ÷ 2.50 = 200 zel.
8. 90 ÷ 15 = 6 years.
9. 40 × 1.15 = 46 zel.
10. Quantity +16%. Revenue: 0.90 × 1.16 = 1.044, so +4.4%.
11. It lowers output and employment, and may cut growth.

Where marks are usually lost

• Reporting a component balance with the wrong sign.
• Placing remittances or aid in trade in services rather than secondary income.
• Forgetting that profit paid abroad is a primary income outflow.
• Claiming a depreciation must cure a deficit without any mention of PED.
• Stopping a chain of reasoning after one step, for example “net exports fall” with no link to GDP or jobs.
• Treating the tariff as money paid to the foreign seller.
• Listing policies with no judgement of how effective they might be.
• Calling every deficit harmful without discussing cause and size.

Official syllabus

The source is the Cambridge O Level Economics 2281 syllabus for 2026 (version 2), published by Cambridge International. These notes cover section 6.4.