This is a question on a homework assignment for one of my business courses. I do

Question

This is a question on a homework assignment for one of my business courses. I do not understand, Help please!

1. The balance of payments account for an economic unit can be specified as:

Current Account = -Capital Account + Reserves,

alternatively:

Earning – Spending = Debt + Assets + Cash

a. The Watts household “imports” thousands of dollars’ worth of food items each year from Aldi), while “exporting” exactly zero dollars’ worth of services to the company. What is the Watts’ current account position (surplus/balance/deficit) with respect to Aldi? What offsetting capital account change(s) make this possible?

b. In the past year, you earned $5,000 from your job at Mega Lo Mart and paid $15,000 in tuition, room, and board to SPU (Small Private University). What is the dollar amount balance on your current account? Assuming you did not reduce your reserves or assets (bank account/ cash), what is the balance on your capital account?

c. Freedonia, a small country with entirely free trade (i.e. zero tariffs or import restrictions), has the following foreign trade data for the past year (all figures in billions):

Exports

Imports

Change in foreign holdings of Freedonia govt. bonds

Foreign Direct Investment (into Freedonia from abroad)

Change in official foreign exch. reserves

$30

$45

$2

$12

($1)

Is Freedonia running a “trade deficit” (current account deficit)? Based on the other data, do you think this is good or bad for Freedonia’s economy? Explain.

Exports

Imports

Change in foreign holdings of Freedonia govt. bonds

Foreign Direct Investment (into Freedonia from abroad)

Change in official foreign exch. reserves

$30

$45

$2

$12

($1)

Explanation / Answer

a) current account = earnings - spendings

watt imports ( spends) food from adli but does not export (earn) anything to him

current account for watt = 0 - spendings = - spendings (imports)

This show that watt is in the current account deficit with respect to adli.

capital account = - (change in debt)

change in debt has made it possible.

b) earnings = $5000

spending = $15000

current account = earnings - spending = 5000 -15000 = -$5000

If i did not use my savings/cash or asset then

capital account = -$10000

3) Trade = export - import = 30 - 45 = -$15

Yes, freedonia running a trade defict.

The balance of payment:

current account = -capital account + change in reserves

or

earnings - spending = change in debt + change in asset + change in cash

35 - 45 = 12 + 2 +1

-15 = 15

Current account deficit of freedonia is financed by capital account and change in reserves. Hence, freedonai is in balance of payment situation.

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