OxfordAQA International AS and A-level Economics: Current account and conflicts (9640) – Revision Notes

Condensed recall for sections 3.2.3.4 and 3.2.3.5 of the OxfordAQA International AS and A-level Economics specification (version 1.2). Section 3.2 is International AS content. For full explanations use the study guide, then test yourself on the practice set. Links: course hub, checklist, free diagnostics. The figures here are made up for illustration; Country B does not exist.

Definitions

Term	Meaning
Balance of payments	A record of a country’s financial transactions with the rest of the world
Current account	Goods, services, primary income and secondary income
Primary income	Income from employment and from investments across borders
Secondary income	One-way transfers, such as remittances and aid
Deficit	Debits exceed credits
Surplus	Credits exceed debits
Positive output gap	Real GDP above productive potential
Negative output gap	Real GDP below productive potential
Deflationary policy	Policy that reduces aggregate demand; it need not cause falling prices

The specification stresses that the current account is only one part of the balance of payments. The rest is for a later unit.

Why trade matters

• Larger markets, so lower average costs.
• Choice, and goods the country cannot produce.
• Competition that pushes firms to improve.
• Exports are part of AD.
• Risks: exposure to foreign downturns, and structural unemployment where imports win.

Formulas

Quantity	Rule
Balance on a part	Credits minus debits
Current account balance	Goods + services + primary + secondary
Share of GDP	Balance / GDP × 100
Unit labour cost	Wage cost per worker / output per worker
Foreign price of an export	Domestic price multiplied by the rate (foreign units bought by one domestic unit)
Domestic price of an import	Foreign price divided by that same rate
Change in quantity	PED × %Δprice, or YED × %Δincome
Output gap (%)	(Real GDP - potential) / potential × 100
Real value	Nominal value / price index × 100

Method boxes

Current account balance. 1. Subtract debits from credits for each part. 2. Add the four balances, keeping signs. 3. Divide by GDP if asked for a share. 4. State deficit or surplus.

Exchange-rate effect. 1. Convert the export price at old and new rates. 2. Work out the percentage change. 3. Apply PED to get the change in quantity. 4. Multiply the price and quantity indices for revenue.

Worked reminders (Country B)

Current account. Billions of B-units, GDP 800.

Part	Credits	Debits	Balance
Goods	180	150	+30
Services	40	50	-10
Primary income	22	30	-8
Secondary income	6	14	-8

Balance = 30 - 10 - 8 - 8 = +4, a surplus of 4 / 800 × 100 = 0.5% of GDP.

Appreciation. An export costs 800 B-units. At 1 B-unit = 1.60 foreign units (F) the price is 1,280 F. After appreciation to 1.76 F it is 1,408 F, up 10%. With PED = -2.0, quantity falls 20%. Foreign-currency revenue index = 1.10 × 0.80 = 0.88, down 12%. Revenue in B-units falls 20%, as the B-unit price is unchanged.

Real terms. A nominal deficit of 30 with a price index of 125 (base 100) is 30 / 125 × 100 = 24 in base-year prices.

Output gaps. Potential 2,500. Real GDP 2,575 gives +3.0%. Real GDP 2,350 gives -6.0%.

Growth and jobs. Output +4%, output per worker +1.5%. Employment changes by 1.04 / 1.015 = 1.0246, so about +2.5%.

Growth and the environment. Output +2% while emissions per unit of output fall 4%. Total emissions index = 1.02 × 0.96 = 0.9792, a fall of 2.1%. Here cleaner technology outweighs the scale of growth.

Growth and distribution. The poorest half has income 300 and the richest half 700 (total 1,000). They grow 2% and 6% to 306 and 742, a total of 1,048 (+4.8%). The poorest half’s share falls from 30.0% to 306 / 1,048 = 29.2%.

Growth and the budget. GDP 2,000, tax 30% of GDP (600), spending 640, so the deficit is 40 (2.0% of GDP). In a downturn GDP falls 4% to 1,920, tax falls to 576 and spending on benefits rises by 12 to 652. The deficit is 76, or 76 / 1,920 = 4.0% of GDP. This is the automatic response of the budget to the cycle.

Factors affecting the current account

Factor	Effect on the balance
Higher productivity	Lower unit costs, more competitive exports, so improves
Higher domestic inflation than partners	Goods relatively dearer, so worsens
Depreciation	Cheaper exports, dearer imports; improves if demands are elastic enough
Appreciation	Opposite of depreciation
Faster growth at home	More imports, so worsens
Faster growth abroad	More exports, so improves

Conflicts between objectives

Conflict	Reasoning chain
Growth and the environment	More output, more resource use and emissions, unless emissions per unit fall faster than output rises
Growth and distribution	Gains may go mostly to higher incomes, so shares can widen even as averages rise
Growth and unemployment	Growth lowers cyclical unemployment unless productivity grows as fast
Growth and budget balance	Growth raises tax and cuts benefits, which helps; but AD-led growth from higher spending widens the deficit
Positive gap	Inflationary pressure, plus more imports, so a worse current account
Negative gap	Cyclical unemployment and weak inflation, so low inflation but poor jobs
Inflation control and jobs	Higher rates cut spending, so inflation falls and unemployment may rise
Cost-push shock	SRAS shifts left; prices rise while output falls, which sharpens the trade-off

Short run: demand-side policy moves along SRAS, so one objective is traded for another. Long run: supply-side policy shifts LRAS right. It can raise output and cut unemployment without adding to inflation, and it improves competitiveness.

Evaluating a conflict

1. State the conflict in one sentence, naming both objectives.
2. Explain the mechanism with AD/AS: which curve shifts, and what happens to the price level, output and jobs.
3. Judge it using at least two of these tests: how much spare capacity exists (the size of the gap), whether the time frame is short or long run, whether the shock comes from demand or from costs, and how responsive imports and exports are.
4. Say how policy might reconcile it, such as separate instruments for separate aims in the short run, or supply-side policy to shift LRAS right in the long run.

Drawing the AD/AS model in words

Axes: price level (vertical) and real GDP (horizontal). LRAS is a vertical line at the normal capacity level of output. SRAS slopes upward. AD slopes downward. Equilibrium is where AD meets SRAS. If that point lies to the right of LRAS, there is a positive output gap. If it lies to the left, there is a negative output gap. A rise in AD shifts the curve right. A cost-push shock shifts SRAS left. Label every curve and both axes.

Must-know distinctions

• Deficit on goods versus deficit on the current account.
• Deflation (prices falling) versus disinflation (inflation falling) versus deflationary policy.
• Appreciation (a rise in the exchange rate) versus depreciation (a fall).
• Short-run trade-off versus long-run supply-side solution.
• Cyclical unemployment (negative gap) versus unemployment from supply-side causes (LRAS position).

Quick self-test

1. Goods exports are 150 and goods imports are 190. State the goods balance.
2. Goods -22, services +12, primary -9, secondary +4. Find the current account balance and its share of GDP of 600.
3. An item costs 250 B-units. The rate falls from 2.00 F to 1.60 F per B-unit. Find the foreign price before and after, and the percentage change.
4. Imports have YED = 2.0 and home income rises 4%. By what percentage do imports rise?
5. A nominal deficit of 45 with a price index of 150. What is it in base-year prices?
6. Actual GDP is 1,940 and potential is 2,000. Find the output gap.
7. Annual wage cost per worker is 36,000 and output per worker is 1,800 units. Find unit labour cost.
8. Define secondary income.
9. Explain why growth can widen inequality.
10. Explain why raising interest rates to cut inflation may worsen unemployment.

Answers

1. 150 - 190 = -40.
2. -22 + 12 - 9 + 4 = -15, and -15 / 600 × 100 = -2.5%.
3. 250 × 2.00 = 500 F before and 250 × 1.60 = 400 F after, so -20%.
4. 2.0 × 4 = 8%.
5. 45 / 150 × 100 = 30.
6. (1,940 - 2,000) / 2,000 × 100 = -3.0%, a negative gap.
7. 36,000 / 1,800 = 20 per unit.
8. One-way transfers with nothing received in return, such as remittances or aid.
9. If gains go mainly to higher incomes, their share rises even though average income grows.
10. Higher rates cut borrowing and spending, so AD falls. Falling output lowers demand for labour.

Where marks are usually lost

• Adding only goods and services and calling it the current account.
• Dropping the sign on a balance, or writing a deficit as a positive number.
• Not stating the unit or whether the figure is a share of GDP.
• Asserting that depreciation improves the balance without naming elasticity or time.
• Reading a percentage change from the wrong base.
• Describing a conflict without an AD/AS step or a named mechanism.
• Treating a short-run trade-off as permanent.
• Missing a final judgement that depends on spare capacity, timing or the cause of the shock.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, first teaching September 2020, published by OxfordAQA: sections 3.2.3.4 and 3.2.3.5.