Balance of payments: notes and practice questions
- This topic covers the structure and components of a country's balance of payments, recording all economic transactions with the rest of the world.
- The balance of payments consists of the current account, capital account, and financial account.
- Credit items represent inflows of money, while debit items represent outflows.
- The current account includes trade in goods and services, income, and current transfers.
- The capital account includes capital transfers and transactions in non-produced, non-financial assets.
- The financial account includes foreign direct investment, portfolio investment, reserve assets, and official borrowing.
- The balance of payments must always sum to zero, meaning credits must equal debits.
How it is examined
At SL this is a calculation and definition subtopic and nothing more. At HL it is one of the richest 15-mark sources in the course, and the Marshall-Lerner condition turns up wherever a question about a depreciation needs a quantitative edge. The May 2025 HL Paper 1 TZ1 mark scheme explicitly told examiners to reward candidates who extended a PED answer into Marshall-Lerner.
- The balance of payments: credit and debit items, and surplus or deficit on an account. (AO1, AO4)
- The components of the balance of payments. (AO2) - Current account: balance of trade in goods, balance of trade in services, income, current transfers. - Capital account: capital transfers, transactions in non-produced non-financial assets. - Financial account: foreign direct investment, portfolio investment, reserve assets, official borrowing.
- The interdependence between the accounts: a zero balance overall, credits matched by debits, and deficits matched by surpluses. (AO2)
- The relationship between the current account and the exchange rate. (AO2, AO4)
- The relationship between the financial account and the exchange rate. (AO2)
- The implications of a persistent current account deficit, in terms of exchange rates, interest rates, foreign ownership of domestic assets, debt, credit ratings, demand management and economic growth. (AO3)
- Methods to correct a persistent current account deficit: expenditure switching, expenditure reducing, and supply-side policies. (AO2)
Guiding questions
- How does a country's account with the rest of the world balance, and what happens when one part of it does not?
Linking questions
- Exchange rate mechanics come from 4.5, and the HL current account and exchange rate rows are the two subtopics meeting.
- PED from 2.5 is what the Marshall-Lerner condition is built from.
- Expenditure reducing is contractionary demand management from 3.5 and 3.6; expenditure switching overlaps with 4.2.
- External balance is a stated goal of both monetary and fiscal policy in 3.5 and 3.6.
Practice questions
1 question · 1 hardQuestion 1
HardPaper 2 · calculator40 marksRead the extracts and answer the questions that follow.
Text A, Overview of the economy and government policies in Vietnam
1 Vietnam has one of the fastest-growing economies in Asia, driven by strong exports and high levels of foreign direct investment (FDI). This growth has transformed the country, lifting millions out of poverty. Major multinational corporations have established large-scale manufacturing facilities, particularly in electronics and textiles, turning Vietnam into a key hub in global supply chains.
2 This rapid industrialization, however, has created challenges. Inflation has become a persistent concern, fueled by rising domestic demand and higher global energy prices. The economy's heavy reliance on imported raw materials and components makes it vulnerable to supply chain disruptions and currency fluctuations.
3 To support its transition to a higher-value economy, the government has offered various incentives. For instance, it provides a subsidy to domestic producers of electric vehicles (EVs) to encourage green technology and reduce reliance on imported fossil fuels. The government has also been actively managing its currency, the Vietnamese dong (VND), to maintain export competitiveness.
Text B, Labour market and social development in Vietnam
1 Vietnam's economic boom has led to a significant structural shift, with millions of workers moving from agriculture to the industrial and service sectors. To ensure a basic standard of living, the government regularly increases the minimum wage. In 2022, the minimum wage was raised by an average of 6%.
2 While poverty has fallen dramatically, inequality is a growing concern. There is a widening gap in income and opportunities between major urban centres like Ho Chi Minh City and Hanoi, and the more remote, rural provinces. Although youth literacy rates are high, there is a recognized skills gap, where the education system is not fully equipping graduates for the demands of the modern high-tech manufacturing sector.
Text C, Vietnam's trade integration and environmental challenges
1 Vietnam is a member of numerous free trade agreements, including the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP). These agreements have boosted exports but also increased competition for domestic firms.
2 The environmental cost of industrialization is becoming increasingly apparent. Air and water pollution in industrial zones are significant problems, creating negative externalities that affect public health and long-term sustainability. The government acknowledges these issues and has set ambitious targets for renewable energy, aiming to attract FDI into solar and wind power projects.
Table 1: Selected macroeconomic data for Vietnam
| 2016 | 2022 | |
|---|---|---|
| Real GDP (USD billion) | 205 | 409 |
| Inflation rate (%) | 2.7 | 3.2 |
| Unemployment rate (%) | 2.3 | 2.3 |
| GNI per capita (USD) | 2190 | 4010 |
Table 2: Vietnam's current account, 2023 (billions of USD)
| 2023 | |
|---|---|
| Exports of goods | 355 |
| Imports of goods | 330 |
| Balance of trade in services | –10 |
| Primary income | –20 |
| Secondary income | 15 |
| Current account balance |
Table 3: Development and trade data for Vietnam
| 2016 | 2022 | |
|---|---|---|
| Population (million) | 93 | 99 |
| Gini coefficient | 0.344 | 0.357 |
| FDI inflows (USD billion) | 12.6 | 15.7 |
(a) (i) Define the term subsidy indicated in bold in the text (Text A, paragraph 3).
(a) (ii) Define the term Gini coefficient indicated in bold in Table 3.
(b) (i) Using information from Table 2, calculate Vietnam's balance of trade in goods for 2023 in billions of USD.
(b) (ii) Using information from Table 2 and your answer to part (b)(i), calculate Vietnam's current account balance for 2023 in billions of USD.
(b) (iii) Sketch a demand and supply diagram to show the effect of a subsidy on the market for electric vehicles in Vietnam (Text A, paragraph 3).
(c) Using an AD/AS diagram, explain how an increase in foreign direct investment (FDI) could affect economic growth in Vietnam (Text A, paragraph 1).
(d) Using a Lorenz curve diagram, explain the change in income inequality in Vietnam between 2016 and 2022 as shown in Table 3.
(e) Using an externalities diagram, explain how industrial production can lead to market failure in Vietnam (Text C, paragraph 2).
(f) Using an exchange rate diagram, explain how a rise in export revenue could affect the value of the Vietnamese dong (VND).
(g) Using information from the text/data and your knowledge of economics, discuss the challenges Vietnam faces in achieving sustainable economic development.
Think about what a government gives to a firm to help it produce more or sell at a lower price. What is the nature of this financial support?
This is a numerical measure of income inequality. How is it derived and what do its extreme values (0 and 1) represent?
The balance of trade in goods is the value of goods exported minus the value of goods imported.
The current account balance is the sum of the balance of trade in goods, the balance of trade in services, primary income, and secondary income.
A subsidy lowers the cost of production for firms. How does this affect the supply curve? Show the new equilibrium price and quantity.
FDI is a form of investment. Which component of aggregate demand (AD) does investment fall under? How would an increase in this component affect the AD curve and, consequently, real GDP?
First, look at the Gini coefficient data in Table 3. Did it increase or decrease? What does this mean for income inequality? Then, draw a Lorenz curve diagram showing two curves, one for 2016 and one for 2022, that reflects this change.
Industrial production often creates pollution. Is pollution a cost to the producer or to society? This creates a divergence between private costs and social costs. Illustrate this on a diagram and explain why it leads to overproduction.
When Vietnam's export revenue rises, what must foreigners do to pay for these exports? Does this affect the demand for or supply of the Vietnamese dong? Show the effect on an exchange rate diagram.
Sustainable development has economic, social, and environmental dimensions. Use the stimulus material to identify challenges in each of these areas (e.g., inflation, inequality, pollution). Then, consider any mitigating factors or policies mentioned. Conclude with a balanced judgement on the severity of these challenges.
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Where marks are lost
- No real-world example, or a stated one. An answer that names a country and stops cannot reach the top two bands.
- One-sided argument. Balance is an explicit axis. A student who argues only that a policy works is capped at 9 out of 15 on that axis alone.
- Diagram present but not explained. The diagram bullet escalates across three bands: included, included and explained, included and fully explained. A diagram dropped into an answer without prose that refers to it sits at 5 to 6 on a 10-mark part.
