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AP®︎/College Macroeconomics
Course: AP®︎/College Macroeconomics > Unit 6
Lesson 1: The balance of paymentsUsing a person's budget to understand the balance of payments
Just like a personal budget, the balance of payments uses the sources of funds and uses of funds to track the movement of money. In this article, we use a young wizard's budget to make the BOP more relatable.
To get a better understanding of the balance of payments accounts, let’s think of a single person’s sources of funds and uses of funds. We can summarize Harry’s budget for this month as shown in the table below:
| Source of funds or use of funds | Amount |
|---|---|
| Income earned from selling copies of his book “Talking to snakes for fun and profit” | + |
| Income earned from owl consultancy services | + |
| Money spent on dementor repellant | |
| Money spent paying for investment advice | |
| Payment from Ron to borrow Harry’s wand | |
| Allowance from Aunt Petunia | |
| Harry’s balance |
Uh oh! Harry ran a little short this month!
Suppose there was one more thing that Harry hasn’t included yet: he also loaned Lucius
Harry’s loan to Lucius and his loan from Hermione are different from the transactions in his budget because the
| Source of funds or use of funds | Amount |
|---|---|
| Loan to Lucius | |
| Loan from Hermione |
Harry’s budget is his current account that summarizes all transactions that have not created liabilities. The transactions that created liabilities are his capital and financial account because those I.O.U. ’s eventually will need to be repaid.
We can summarize these in the table below:
| Source of funds or use of funds | Amount |
|---|---|
| Income earned from selling copies of his book “Talking to snakes for fun and profit” | |
| Income earned from owl consultancy services | |
| Money spent on dementor repellant | |
| Money spent paying for investment advice | |
| Wand rent | |
| Allowance from Aunt Petunia: | |
| Harry’s current account balance | |
| Outflow of money loaned | |
| Inflow of money borrowed from Hermione | |
| Harry’s Capital and Financial Account balance |
We can relate a country’s balance of payments account to the scenario we described above. The table below shows entries for the nation of Panem that are comparable to each of the entries on Harry’s Balance sheet:
| Harry's source of funds or use of funds | Harry's Amount | Panem's amount (in billions) | Panem's category of BOP |
|---|---|---|---|
| Income earned from selling copies of his book “Talking to snakes for fun and profit” | Goods exports | ||
| Money spent on dementor repellant | Goods imports | ||
| Balance on goods | Balance on goods | ||
| Money spent paying for investment advice | Service imports | ||
| Income earned from owl consultancy services | Service exports | ||
| Balance on services | Balance on services | ||
| Wand rent | Net investment income (also called factor income) | ||
| Allowance from Aunt Petunia | Transfers and remittances | ||
| Harry’s current account balance | Panem’s current account balance | ||
| Outflow of money loaned | Outflow of foreign assets from Panem | ||
| Inflow of money borrowed from Hermione | Inflow of foreign assets to Panem | ||
| Harry's capital and financial account balance | Panem’s capital and financial account balance | ||
| Balance of payments | Balance of payments |
Want to join the conversation?
This question might be rather stupid but how do we account for transactions that are made with previously saved money? Meaning we don't get the money to transact (current account) from a loan (capital account) but from money we already have?(14 votes)
If Harry used up $318 of his own wealth instead of borrowing it, then there will be a transfer of money from Harry to other people. But money is a financial asset! So this is a transfer of a financial asset from a country (Harry) to another country (everyone else), which increases the capital account.(2 votes)
- How does a surplus in Financial Accts help offset a current account deficit? Since, a surplus in Financial Accts means you took out loans that you have to repay later, doesn't that just increase our overall deficit in the long run?(3 votes)
This is very much like accounting. Wow.(2 votes)- can we have a trade deficit balance despite surplus current account balance?(1 vote)
- yes it is quite possible. suppose a poor county has to import more than export (trade deficit) by $100m. It recieves foriegn aid by US of $200m .Assuming the country has 0 net investment incomr the current account will have a surplus of $100m.(1 vote)
- what does CFA stand for?(1 vote)
- If an asset is paid off, like say rent is given, that would fall in current account right but then why would it need to be again repaid
What i mean is that Hermione helped Harry by giving him money but what do countries do
or lets rephrase
do countries have to work to balance the accounts or does it happen automatically(0 votes) 
so sal was on a harry potter kick good to know little bro might be happier than me because i am not that big of a potterhead i know a little dit were as my little bro is a big time potterhead
side note wouldn't be in pounds not dollars everyone in the harry potter series english like from england becuase she as hell dont sound american they have a english accsent and considering they are kids they would have to pick it from there friend or parents(0 votes)