Module 41
May 2015
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Balance of payment accounts – a summary of the
country’s transactions with other countries
In the upcoming table:
◦ 1. shows payments that arise from sales and purchases
of goods and services (wheat exports in first column of
numbers, oil imports in the 2nd)
◦ 2. factor income – payments for the use of factors of
production owned by residents of other countries –
mostly this is investment income – interest paid on loans
from overseas, profits earned by Disneyland Paris. In the
2nd column are profits earned by the U.S. operations of
Japanese auto co. - includes labor income, for ex.
American engineer working in Dubai
◦ 3. international transfers – funds sent by residents of
one country to residents of another – remittances that
immigrants, such as the millions of Mexican-born
workers employed in the U.S. send to their families in
their countries of origin – this table shows the NET not a
breakdown between payments to foreigners and
payments from foreigners
◦ 4. the next two rows show payments resulting from
sales and purchases of assets, broken down by who is
doing the buying and selling
◦ 4. shows transactions that involve governments or
government agencies, mainly central banks
◦ 5. shows private sales and purchases of assets like the
purchase of Budweiser by a Belgian corporation.
Table 41.2 The U.S. Balance of Payments in 2008 (billions of dollars)
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
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When a U.S. resident sells a good, such as
wheat, to a foreigner, that’s the end of the
transaction. But a financial asset, such as a
bond, is different. A bond is a promise to
pay interest and principal in the future. So its
sale is a liability, the U.S. will have to pay
interest and repay principal in the future
The balance of payments accounts
distinguish between transactions that don’t
create liabilities and those that do.
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Balance of payments on the current account
or just current account – is the balance of
payments on goods and services plus net
international transfer payments and factor
income
Balance of payments on goods and services –
the difference between its exports and its
import during a given period
Merchandise trade balance, or trade balance –
the difference between a country’s exports
and imports of goods
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Balance of payments on the financial account
or simply the financial account – the
difference between its sales of assets to
foreigners and its purchases of assets from
foreigners during a given period.
Current account (CA) + Financial account (FA) = 0
Figure 41.1 The Balance of Payments
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers

The blue arrows represent payments that are
counted in the current account. The red
arrows represent payments that are counted
in the financial account. Because the total
flow into the U.S. must equal the total flow
out of the U.S., the sum of the current
account plus the financial account is zero
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Financial capital – funds from sawings that
are available for investment spending
Capital inflows – foreign savings that have
become available to finance domestic
investment spending
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According to the loanable funds model of the
interest rate, the equilibrium interest rate is
determined by the intersection of the supply
of loanable funds curse, S, and the demand
for loanable funds, D. At point E, the
equilibrium interest rate is 4%.
Figure 41.2 The Loanable Funds Model Revisited
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers

The U.S. and Britain, each with its own
loanable funds market. The equilibrium
interest rate is 6% in the U.S. market but only
2% in the British market. This creates an
incentive for capital to flow from Britain to
the U.S.
Figure 41.3 Loanable Funds Markets in Two Countries
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers

British lenders lend to borrowers in the U.S.
leading to equalization of interest rates at 4%
in both countries. At that rate, American
borrowing exceeds American lending; the
difference is made up by capital inflows to
the U.S. Meanwhile, British lending exceeds
British borrowing; the excess is a capital
outflow from Britain.
Figure 41.4 International Capital Flows
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers