2.6.3 The Balance of Payments — Practice Questions

Nine original multiple-choice questions on the balance of payments, written to the style and difficulty of AQA Paper 3 Section A.

9 questions AQA A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 2.6.3 The Balance of Payments revision notes.

1. 1. Trade in goods and services, primary income and secondary income are together recorded in the

   Definition in context

   Select one answer

   A Capital account.

   B Current account.

   C Financial account.

   D Reserve account.
   Show model answer

   Answer: B (Current account.). The current account has exactly these four components. It is the part of the balance of payments that records income earned and spent across borders in the ordinary course of trade and transfers.

   Why the other options are wrong

   • A — The capital account records relatively minor transfers of ownership, such as debt forgiveness and transfers of fixed assets.
   • C — The financial account records flows of investment — foreign direct investment, portfolio investment and changes in reserves.
   • D — Reserve assets are a component within the financial account, not an account in their own right.

2. 2. Table 1 shows a country's international transactions for one year. Credits are inflows and debits are outflows.
   Using Table 1, the current account balance is

   Calculation

   Table 1: International transactions

   Component	Credits	Debits
   Trade in goods	£240bn	£350bn
   Trade in services	£180bn	£105bn
   Primary income	£60bn	£45bn
   Secondary income	£15bn	£35bn

   Select one answer

   A −£110bn

   B −£40bn

   C −£20bn

   D +£40bn
   Show model answer

   Answer: B (−£40bn). Net each component first, then add the four together.
   Goods: 240 − 350 = −£110bn.
   Services: 180 − 105 = +£75bn.
   Primary income: 60 − 45 = +£15bn.
   Secondary income: 15 − 35 = −£20bn.
   Current account = −110 + 75 + 15 − 20 = −£40bn.
   Checking the other way gives the same answer: total credits of £495bn less total debits of £535bn is −£40bn.

   Why the other options are wrong

   • A — −£110bn is the balance on trade in goods alone. Quoting it as the current account ignores a large services surplus and overstates the deficit nearly threefold.
   • C — −£20bn leaves secondary income out: −110 + 75 + 15. Transfers such as aid and remittances are part of the current account.
   • D — +£40bn is the right size with the sign reversed, which comes from subtracting credits from debits instead of the other way round.

3. 3. A country runs a large deficit on its current account. It follows that

   Applied reasoning

   Select one answer

   A It must run a surplus on its capital and financial accounts.

   B Its capital and financial accounts must also be in deficit.

   C Its currency must be fixed against other currencies.

   D Its exports must exceed its imports.
   Show model answer

   Answer: A (It must run a surplus on its capital and financial accounts.). The balance of payments must balance, because every transaction is recorded twice. A country buying more from abroad than it sells must be financing the difference — by borrowing, by selling assets to foreign investors, or by running down its reserves.
   All of those are recorded as credits on the capital and financial accounts. So a current account deficit is matched by a surplus there, of the same size.

   Why the other options are wrong

   • B — If both were in deficit the balance of payments would not balance, which is impossible by construction.
   • C — Deficits occur under floating and fixed systems alike. The exchange rate regime affects how a deficit adjusts, not whether it can exist.
   • D — Exports exceeding imports would tend to produce a surplus, not a deficit.

4. 4. A country's currency appreciates strongly and remains high for several years. The most likely effect on its current account is that it

   Applied reasoning

   Select one answer

   A Improves, because exports become cheaper abroad.

   B Improves, because imports become dearer at home.

   C Worsens, because exports become dearer abroad.

   D Worsens, because imports become dearer at home.
   Show model answer

   Answer: C (Worsens, because exports become dearer abroad.). A stronger currency means each unit buys more foreign currency. Domestic goods priced in the home currency therefore cost overseas buyers more, so exports become less competitive and export volumes fall.
   At the same time imports become cheaper at home, so import volumes rise. Both effects push the current account towards deficit. This is one of the standard causes of a persistent deficit, alongside weak competitiveness and strong domestic demand.

   Why the other options are wrong

   • A — An appreciation makes exports dearer abroad, not cheaper. That is a depreciation.
   • B — Imports become cheaper under an appreciation, and cheaper imports worsen the balance rather than improving it.
   • D — The direction of the effect is right but the reason is wrong: imports become cheaper, and it is that which pulls imports in.

5. 5. A government raises tariffs on imported goods in order to reduce a current account deficit. This is best described as

   Definition in context

   Select one answer

   A A monetary policy.

   B A supply-side policy.

   C An expenditure-reducing policy.

   D An expenditure-switching policy.
   Show model answer

   Answer: D (An expenditure-switching policy.). Expenditure-switching policies aim to shift demand away from imports and towards domestically produced goods, without necessarily reducing total spending. Tariffs, quotas and devaluation all work this way.
   The standard objections are retaliation from trading partners and higher prices for domestic consumers.

   Why the other options are wrong

   • A — Monetary policy works through interest rates and the money supply. A tariff is a tax on imports.
   • B — Supply-side policy raises the competitiveness of domestic industry over the long run, through investment in skills, infrastructure and innovation.
   • C — Expenditure-reducing policies cut total demand — through higher taxes or higher interest rates — so that imports fall along with everything else. A tariff redirects spending rather than shrinking it.

6. 6. A government raises income tax and cuts its own spending, partly in order to reduce a current account deficit. This works by

   Applied reasoning

   Select one answer

   A Increasing the country's foreign currency reserves.

   B Making imports relatively dearer than domestic goods.

   C Reducing domestic demand, so fewer imports are bought.

   D Raising the competitiveness of domestic exporters.
   Show model answer

   Answer: C (Reducing domestic demand, so fewer imports are bought.). This is an expenditure-reducing policy. Contractionary fiscal policy lowers households' disposable income and total demand in the economy. Since a share of all spending goes on imports, lower spending means fewer imports and a narrower deficit.
   The cost is that the policy works by making the economy weaker: growth slows and unemployment rises. That conflict is why it is rarely used for this purpose alone.

   Why the other options are wrong

   • A — Reserves are affected by central bank intervention in currency markets, not by fiscal policy.
   • B — Changing relative prices between imports and domestic goods is expenditure switching, achieved by tariffs or a devaluation.
   • D — Competitiveness is raised by supply-side measures over the long run. Higher taxes do not make exporters more competitive.

7. 7. A government proposes investment in education, training and infrastructure as the route to reducing a current account deficit. The main drawback of this approach is that it

   Applied reasoning

   Select one answer

   A Cannot affect the competitiveness of exports.

   B Provokes retaliation from trading partners.

   C Raises the price of imported goods.

   D Takes many years to have an effect.
   Show model answer

   Answer: D (Takes many years to have an effect.). Supply-side measures address the root cause — weak competitiveness — rather than the symptom, and they do not invite retaliation or raise consumer prices. On the economics they are the strongest of the three approaches.
   The problem is time. Better-trained workers and new infrastructure take a decade to change what an economy can produce and sell, so a government facing an urgent deficit cannot rely on them alone.

   Why the other options are wrong

   • A — Raising competitiveness is exactly what these measures do, by improving productivity and the quality of what is produced.
   • B — Retaliation is a risk of protectionist expenditure-switching policies. Investing in your own workforce provokes none.
   • C — Tariffs raise import prices. Investment in skills and infrastructure does not.

8. 8. Table 1 shows the four components of a country's current account in two consecutive years.
   Using Table 1, the component mainly responsible for the move into deficit is

   Data interpretation

   Table 1: Current account components, £bn

   Component	Year 1	Year 2
   Trade in goods	−80	−140
   Trade in services	+70	+72
   Primary income	+20	+19
   Secondary income	−10	−11

   Select one answer

   A Primary income.

   B Secondary income.

   C Trade in goods.

   D Trade in services.
   Show model answer

   Answer: C (Trade in goods.). The current account moved from balance to a £60bn deficit, so look for the component that changed by about £60bn.
   Goods: −80 to −140, a deterioration of £60bn.
   Services: +70 to +72, an improvement of £2bn.
   Primary income: +20 to +19, and secondary income: −10 to −11, each a change of just £1bn.
   Trade in goods accounts for essentially the whole movement. The size of a component's balance matters less than how much it has changed.

   Why the other options are wrong

   • A — Primary income worsened by only £1bn. It is in surplus in both years and barely moved.
   • B — Secondary income worsened by £1bn. It is the smallest component and cannot explain a £60bn swing.
   • D — Services actually improved by £2bn, partly offsetting the deterioration rather than causing it.

9. 9. A country runs a large current account surplus for many years. A genuine economic concern is that it

   Applied reasoning

   Select one answer

   A Becomes unable to finance its imports.

   B Grows over-reliant on demand from abroad.

   C Must borrow heavily from abroad to continue.

   D Will suffer a shortage of foreign currency.
   Show model answer

   Answer: B (Grows over-reliant on demand from abroad.). Surpluses are often assumed to be straightforwardly good, but a persistent one means growth is being driven by external demand rather than domestic consumption and investment. That leaves the economy badly exposed to a global recession or a shift in trading partners' spending.
   A large surplus also adds to aggregate demand and can generate inflationary pressure at home, and it can strain relations with deficit countries.

   Why the other options are wrong

   • A — A surplus country earns more foreign currency than it spends, so financing imports is precisely what it can do comfortably.
   • C — Borrowing from abroad is the position of a deficit country, which must finance the gap through the financial account.
   • D — A shortage of foreign currency is a deficit country's problem. A surplus country is accumulating foreign currency.