Chapter 18, Problem 5P

To determine

Concept Introduction:

Balance of Payment (BOP):

It is an account of what is received by the residents of the country from the rest of the world and what these residents have paid out to other countries on the account of the sale of goods, services and other invisible items as well as on the account of capital transfers from other countries. It is divided into two accounts.

Current Account: It maintains all the transactions related to the exchange of goods and services and unilateral transfers. It includes shipping insurance and banking services, investment income, foreign travel, transfer payments and balance of trade.

Financial Account:

It provides details of all the capital transfers such as investment and loans between one country and the rest of the world. Some components are banking capital, official capital, private capital, gold and foreign capital.

Relation between Current Account and Financial Account:

In an economy, the sum of both current account and balance account is zero because they are balanced.

The relation between them is,

To explain: Change in demand, supply, interest rate and BOP on current and financial account due to the capital flows between Northlandia and Southlandia.