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Class 12 Open Economy Macroeconomics: cheat sheet
CBSE Social Science. An economy trading with the world: the balance of payments, current and capital accounts, trade balance, exchange rates, depreciation and devaluation, and purchasing power parity.
Key ideas
- The balance of payments records all of a country’s transactions with the rest of the world in a year.
- The current account records trade in goods and services, incomes and transfers; the capital account records transactions in assets such as FDI, portfolio investment and loans.
- Exports minus imports of goods is the balance of trade; services, incomes and transfers are the invisibles.
- Autonomous transactions are made for their own sake; accommodating ones (official reserve changes) cover the gap that is left.
- Under a flexible rate, the exchange rate is set by the demand for and supply of foreign exchange; more demand for dollars makes the rupee depreciate.
- Depreciation is a market fall in a currency’s value; devaluation is a fall fixed by the government; managed floating lets the central bank limit swings.
- Purchasing power parity says that in the long run the exchange rate makes the same good cost the same in every country.
Remember
| Balance of trade | exports of goods − imports of goods |
| Current account balance | balance of trade + net invisibles |
| Overall balance | current account + capital account + errors and omissions (a surplus adds to reserves) |
| Rupee cost of an import | dollar price × rupees per dollar |
| Change in the exchange rate | (new rate − old rate) ÷ old rate × 100 |
| Purchasing power parity | exchange rate = price in India (₹) ÷ price abroad ($) |
Watch out
- Saying the rupee appreciates when the rupee price of a dollar rises (it depreciates).
- Putting FDI in the current account (it belongs in the capital account).
- Mixing up depreciation (market) and devaluation (set by the government).
Worked example
Suppose a country (₹ crore) exports goods worth 1010 and imports goods worth 690; net invisibles are 120 and the capital account balance is 300. (a) Find the balance of trade. (b) Find the current account balance. (c) Find the overall BoP and say what the central bank must do with its reserves.
Working: 1,010 − 690; then + 120; then + 300
Answer: (a) ₹320 crore (b) ₹440 crore (c) a surplus of ₹740 crore; reserves rise by ₹740 crore
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