IB DP Economics: Balance of payments – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – the IB holds copyright in its own papers. Use these alongside the official past papers available through your school or the IB store.

These questions follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. They cover sub-topic 4.6, Balance of payments. Questions 1 to 5 suit SL and HL. Questions 6 to 11 are labelled “HL only”. All countries and figures are invented. The [1] points in the answers are a revision aid, not IB marks.

Read the study guide or the revision notes first. See also the IB DP Economics hub, the printable checklist and the free 10-minute diagnostics.

Questions

1. Distinguish between a credit item and a debit item in the balance of payments, giving one example of each. [3]

2. The fictional country Ardovia has these figures, in billions of ards. Goods: exports 310, imports 285. Services: exports 70, imports 96. Income: credits 40, debits 55. Current transfers: credits 22, debits 12.

(a) Calculate the balance on goods, services, income and current transfers. [4] (b) Calculate the current account balance. [1]

3. State the account and item, and whether each is a credit or a debit for Ardovia. [4]

• A foreign company builds a factory in Ardovia.
• Ardovians working abroad send money to their families at home.
• Ardovia’s central bank buys foreign currency, adding to its reserves.
• An Ardovia resident pays a foreign hotel for a holiday.

4. Ardovia has a current account balance of -6 and a capital account balance of +2. Net FDI is +7, net portfolio investment is -5 and net official borrowing is +3 (billions of ards).

(a) Calculate the balance on the financial account. [2] (b) Calculate the balance on reserve assets. [2] (c) State whether reserves rose or fell. [1]

5. Explain, with a numerical example, why the balance of payments as a whole sums to zero. [4]

6. (HL only) Ardovia’s currency, the ard, is held at a rate above its equilibrium rate and the country has a current account deficit. Draw a currency market diagram and explain the link between the deficit and the exchange rate. [5]

7. (HL only) Explain how a rise in Ardovia’s interest rates might change the financial account, the exchange rate and the current account. [4]

8. (HL only) The fictional country Tessmar has exports of 250 and imports of 280 (billions of tesses). The tess depreciates by 5%. Assume export prices in tesses and import prices in foreign currency do not change.

(a) State the Marshall-Lerner condition. [1] (b) Export demand has a price elasticity of 0.8 and import demand 0.5. Show that the condition is met. [1] (c) Calculate the new current account balance. [3] (d) In the short run the elasticities are 0.3 and 0.2. Calculate the new balance and explain what this shows about the J-curve. [2]

9. (HL only) Discuss expenditure switching and expenditure reducing as methods of correcting a persistent current account deficit. [8]

10. (HL only) Explain two implications of a persistent current account surplus. [4]

11. (HL only) Tessmar has run a current account deficit of 30 a year for ten years. GDP is 600. Most of the deficit is financed by inflows of portfolio investment.

(a) Calculate the deficit as a percentage of GDP. [1] (b) Evaluate the implications of this persistent deficit. [9]

Answers

1. A credit item brings money into the country, for example an export sale [1]. A debit item sends money out of the country, for example an import purchase [1]. The difference is the direction of the money flow: in for credits, out for debits [1]. Examiner insight: “Distinguish” asks for a difference, so state both definitions clearly before the examples.

2. (a) Goods = 310 - 285 = +25 [1]. Services = 70 - 96 = -26 [1]. Income = 40 - 55 = -15 [1]. Current transfers = 22 - 12 = +10 [1]. (b) 25 - 26 - 15 + 10 = -6, a deficit of 6 billion ards [1]. Examiner insight: Showing each balance as credits minus debits makes the working easy to follow, and the sign carries the surplus or deficit.

3. Financial account, FDI, credit [1]. Current account, current transfers, credit [1]. Financial account, reserve assets, debit [1]. Current account, trade in services, debit [1]. Examiner insight: Name the account and the item as well as the direction, because the question asks for all three.

4. (a) Financial account = -(-6 + 2) [1] = +4 [1]. (b) Reserve assets = 4 - (7 - 5 + 3) [1] = 4 - 5 = -1 [1]. (c) A debit means reserves rose by 1 [1]. Examiner insight: Check the final answer against the zero-sum rule: all four financial items should add to the financial account.

5. Each transaction is recorded twice, once as a credit and once as a debit [1]. Example: Ardovia exports goods worth 8, a credit on the current account [1]. The foreign buyer pays, so an Ardovia bank gains a foreign deposit, an outflow of financial capital recorded as a debit of 8 on the financial account [1]. Credits equal debits, so the accounts sum to zero, and a deficit on one account is matched by a surplus on another [1]. Examiner insight: A numerical example is asked for, so give the amount and the account for both sides.

6. Axes: exchange rate on the vertical axis, quantity of ards on the horizontal axis [1]. Demand falling to the right (exports) and supply rising (imports), with equilibrium labelled [1]. The held rate is marked above equilibrium [1]. At that rate supply exceeds demand, matching the deficit, and puts downward pressure on the ard [1]. If the rate floats, depreciation lowers export prices abroad and raises import prices, narrowing the deficit [1]. Examiner insight: A diagram earns more when each curve, axis and rate is labelled and the explanation refers to the labels.

7. Higher interest rates attract portfolio investment, raising the financial account surplus [1]. Foreign investors demand more ards, so demand shifts right [1] and the ard appreciates [1]. Exports become dearer and imports cheaper, so the current account worsens [1]. Examiner insight: Follow the chain link by link and end with the current account, since the question names all three accounts.

8. (a) A depreciation improves the current account only if, ignoring signs, the two price elasticities (exports and imports) add to more than 1 [1]. (b) 0.8 + 0.5 = 1.3, which is greater than 1 [1]. (c) Exports = 250 × (1 + 0.8 × 0.05) = 250 × 1.04 = 260 [1]. Imports = 280 × 1.05 × (1 - 0.5 × 0.05) = 280 × 1.05 × 0.975 = 286.65 [1]. Balance = 260 - 286.65 = -26.65, better than -30 [1]. (d) Exports = 250 × 1.015 = 253.75; imports = 280 × 1.05 × 0.99 = 291.06; balance = -37.31 [1]. The deficit widens at first, then narrows as elasticities rise, which is the J-curve [1]. Examiner insight: Show how each volume change is applied to the price change, because a bare final figure gives no way to credit sound working.

9. Switching redirects spending to home output through tariffs, quotas, subsidies or depreciation [1]. It acts quickly on trade flows [1]. Limits: retaliation by trading partners [1]; depreciation depends on elasticities (Marshall-Lerner) and raises import prices [1]. Reducing cuts demand through tax rises, spending cuts or dearer borrowing [1]. It cuts imports directly [1] but lowers output, jobs and growth [1]. Judgement: the better method depends on the cause of the deficit, so switching suits a competitiveness problem if elasticities are high, and reducing suits a consumption boom [1]. Examiner insight: “Discuss” calls for both methods weighed against each other, so finish with a reasoned judgement tied to a cause.

10. Two implications, each explained, earn two each. Exchange rates: strong foreign demand for the currency pushes it up, which raises export prices abroad [2]. Consumption and investment: output sold abroad is not used at home, so consumption and investment may be lower than they could be [2]. Other valid answers: inflation (export demand adds to aggregate demand) and employment (export jobs, but appreciation can cost some of them). Examiner insight: Naming an implication is not enough, so add one step of reasoning to each.

11. (a) 30 / 600 = 5.0% [1]. (b) Exchange rate: persistent deficit pressure may weaken the currency, but portfolio inflows can support it for now [1]. Interest rates may have to stay high to attract inflows, raising borrowing costs [1]. Portfolio inflows can reverse quickly if confidence falls, causing a sharp depreciation [1]. Ten deficits of about 30 add to external liabilities, so debt and interest payments grow [1]. Foreign ownership of assets rises and income flows out [1]. A credit rating agency may judge the country riskier, raising future borrowing costs [1]. Demand management is constrained, since faster growth pulls in imports [1]. If the imports are capital goods, growth may rise, but if they are consumer goods it does not [1]. Judgement: 5.0% for ten years financed by short-term flows is a risk, and the verdict depends on what the imports funded [1]. Examiner insight: Evaluation improves when you use the case details (size, length, financing) to decide how serious the deficit is.

Where marks are usually lost

• Writing “deficit in the balance of payments” without naming an account.
• Reversing credits and debits, so balances carry the wrong sign.
• Taking the financial account as equal to the current account instead of minus the current plus capital accounts.
• Treating a rise in reserves as a credit.
• Not showing working in calculations with elasticities and depreciation.
• Drawing a currency diagram without labelled axes, curves or equilibrium.
• Assuming depreciation must cure a deficit, with no elasticities or time lag.
• Listing implications of a deficit with no judgement about size, cause or financing.

Next steps

• Review the revision notes and the study guide.
• Go to the IB DP Economics hub and tick off the printable checklist.
• Link this unit to exchange rates in the same course.
• Try all free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published by the International Baccalaureate Organization (February 2020), sub-topic 4.6 Balance of payments (includes HL only sub-topics).