SUBMITTED TO

SIR MOAZZAM

SUBMITTED BY
M SAAD
M USMAN
NEHA
FAHEEM ALI
ARMAN MARWAT

FINAL REPORT SHER ALI

SHOAIB NAEEM

Principles of Macroeconomics
Contents
Key concepts:............................................................................................................................................... 2
Balance of Payment Accounts:................................................................................................................... 2
1. Current Account: .................................................................................................................................... 3
2.Capital Account: ...................................................................................................................................... 3
3.Financial Account: ................................................................................................................................... 3
Balance of Payment VS Balance of Trade: ............................................................................................... 4
Balance of Payments (BOP): ...................................................................................................................... 4
Balance of Trade: ........................................................................................................................................ 4
Example ......................................................................................................................................................... 5
Disequilibrium & Imbalance of Payments: .............................................................................................. 6
Disequilibrium: ........................................................................................................................................... 6
Imbalance: ................................................................................................................................................... 6
Example:........................................................................................................................................................ 7
Causes and Remedies of Disequilibrium & Imbalance of Payments: .................................................... 7
Causes of disequilibrium and imbalance of Payments: ........................................................................... 7
Remedies/Measure to correct disequilibrium in the Balance of Payments: .......................................... 8
Concept of Business cycle & phases of Business cycle: ............................................................................ 9
1. Expansion (Recovery):........................................................................................................................ 9
2. Peak: ................................................................................................................................................... 10
3. Contraction (Recession or Downturn): ........................................................................................... 10
4. Trough: .............................................................................................................................................. 11
Causes of Business cycle & Introduction of theories of trade cycle: .................................................... 11
Causes of the Business Cycle: .................................................................................................................. 11
Introduction to Theories of Trade Cycle: ............................................................................................... 12
1. Keynesian Theory: ............................................................................................................................ 13
2. Monetarist Theory: ........................................................................................................................... 13
3. Real Business Cycle Theory: ............................................................................................................ 13
 Balance of payments
Balance of payments is a statistical statement that systematically summarizes, for a specific time
period, the economic transactions of an economy with the rest of the world.
Economic transactions, for the most part between residents and nonresidents, consist of those
involving goods, services, and income; those involving financial claims on, and liabilities to the
rest of the world; and those (such as gifts), classified as transfers. A transaction itself is defined
as an economic flow that reflects the creation, transformation, exchange, transfer, or extinction
of economic value and involves changes in ownership of goods and/ or financial assets, the
provision of services, or the provision of labor and capital.

Key concepts:
• Double entry system: the basic convention applied in constructing a balance of payments
statement is that every recorded transaction is represented by two entries with equal values.
One of these entries is designated a credit with a positive arithmetic sign; the other is designated
a debit with a negative sign. In principle, the sum of all credit entries is identical to the sum of all
debit entries, and the net balance of all entries in the statement is zero.

• Concept of residence: residence is particularly important attribute of an institutional unit in the

balance of payments because the identification of transactions between residents and
nonresidents underpins the system. The concept of residence is based on sectoral transactor’s
center of economic interest. An institutional unit has a center of economic interest and is a
resident unit of a country when from some location, dwelling, place of production, or other
premises within the economic territory of country, the unit engages and intends to continue
engaging, either indefinitely or over a finite period usually a year, in economic activities and
transactions on a significant scale. The one-year period is suggested only as a guideline and not
as an inflexible rule.

• Time of recording: In balance of payments the principle of accrual accounting governs the time
of recording of transactions. Therefore, transactions are recorded when economic value is
created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when
there is a change in ownership.

Balance of Payment Accounts:

The Balance of Payments (BOP) is a systematic record of a country's economic transactions with
the rest of the world over a specific period. It consists of various accounts that provide insights
into the economic interactions between a country and other nations. The BOP accounts are
typically categorized into three main components: the Current Account, the Capital Account, and
the Financial Account.
1. Current Account:
• Trade Balance (or Merchandise Trade Balance): This account includes the
balance of trade in goods, which is the difference between a country's exports and
imports of physical goods. If a country exports more than it imports, it has a trade
surplus; if it imports more than it exports, it has a trade deficit.
• Services Balance: This accounts for the value of services (such as tourism,
transportation, and business services) that a country exports or imports.
• Income Balance: This includes earnings from foreign investments and payments
on foreign debts.
• Current Transfers: This accounts for unilateral transfers, such as foreign aid and
remittances.
The Current Account balance is calculated as the sum of the trade balance, services balance,
income balance, and current transfers.

2.Capital Account:
The Capital Account records transactions related to non-financial assets, such as the sale or
purchase of fixed assets. It also includes transfers of ownership of fixed assets.

3.Financial Account:
The Financial Account captures transactions involving financial assets and liabilities. It includes:
a. Foreign Direct Investment (FDI): Investments made by one country into another
with the intent of establishing a lasting interest.
b. Foreign Portfolio Investment (FPI): Investments made by individuals or
institutions into financial assets, such as stocks and bonds, in another country.
c. Official Reserves Account: Changes in a country's reserves of foreign currencies
and gold.
Example: Consider a hypothetical country called XYZ. Here is a simplified example of its BOP
accounts:
3.Current Account:
• Trade Balance: +$10 billion (exports exceed imports)
• Services Balance: -$5 billion (more spent on services from other countries than
earned)
• Income Balance: +$2 billion (earnings from foreign investments exceed payments
on foreign debts)
• Current Transfers: -$1 billion (net outflow in unilateral transfers)
Current Account Balance = $10B - $5B + $2B - $1B = +$6 billion
• Capital Account:
• Sale of Government Assets: +$3 billion
• Purchase of Foreign Assets: -$2 billion
Capital Account Balance = +$3B - $2B = +$1 billion
• Financial Account:
• Foreign Direct Investment (FDI): +$8 billion
• Foreign Portfolio Investment (FPI): -$4 billion
• Changes in Reserves: -$5 billion
Financial Account Balance = +$8B - $4B - $5B = -$1 billion
In this example, the Current Account surplus of $6 billion is offset by a Financial Account deficit
of $1 billion, resulting in a surplus in the overall balance of payments of $5 billion. This surplus
would typically lead to an increase in the country's official reserves.

Balance of Payment VS Balance of Trade:

The Balance of Payments (BOP) and the Balance of Trade are related economic indicators that
provide insights into a country's economic interactions with the rest of the world, but they focus
on different aspects of these interactions.

Balance of Payments (BOP):

• Definition: The Balance of Payments is a comprehensive record of all economic
transactions between a country and the rest of the world over a specific period.
• Components: It includes the Current Account, the Capital Account, and the
Financial Account.
• Purpose: The BOP provides a holistic view of a country's economic position in the
global context, considering not only trade in goods but also services, income, and
financial transactions.

Balance of Trade:
• Definition: The Balance of Trade is a component of the Current Account in the
Balance of Payments and specifically focuses on the difference between a country's
exports and imports of goods (physical products).
• Components: It includes the trade balance, which is the difference between the
value of exports and imports of goods.
 • Purpose: The Balance of Trade helps assess whether a country has a trade surplus
(more exports than imports) or a trade deficit (more imports than exports) in
tangible goods.

Example: Let's use a hypothetical country called ABC to illustrate the concepts.
• Balance of Trade:
• Exports of Goods: $120 billion
• Imports of Goods: $90 billion
Balance of Trade = $120B (exports) - $90B (imports) = +$30 billion (trade surplus)
In this example, Country ABC has a trade surplus of $30 billion because it exports $30 billion
more in goods than it imports.
• Balance of Payments:
• Balance of Trade (Current Account): +$30 billion (as calculated above)
• Services Balance: -$10 billion (more spent on services from other countries than
earned)
• Income Balance: -$5 billion (earnings from foreign investments are less than
payments on foreign debts)
• Current Transfers: -$2 billion (net outflow in unilateral transfers)
• Capital Account: +$5 billion (e.g., sale of government assets)
• Financial Account: -$8 billion (e.g., net outflow of foreign direct investment and
portfolio investment)
Overall Balance of Payments = +$30B - $10B - $5B - $2B + $5B - $8B = +$10 billion
In this example, Country ABC has a trade surplus of $30 billion, but when considering other
components like services, income, and financial transactions, the overall Balance of Payments is
a surplus of $10 billion. The Balance of Payments provides a more comprehensive picture of the
country's economic transactions with the rest of the world, taking into account a broader range of
activities beyond just the trade in goods.
Disequilibrium & Imbalance of Payments:
"Disequilibrium" and "imbalance" in the context of balance of payments refer to situations where
a country's economic transactions with the rest of the world result in a lack of balance or
equilibrium. These terms are used to describe conditions where there are deficits or surpluses in
different components of the balance of payments.

Disequilibrium:
• Definition: Disequilibrium in the balance of payments occurs when there is an
overall imbalance between a country's receipts (exports and other inflows) and its
payments (imports and other outflows) over a specific period.
• Causes: Disequilibrium can arise due to various factors, including trade
imbalances, fluctuations in currency exchange rates, changes in global economic
conditions, and shifts in investor confidence.
• Implications: Persistent disequilibrium may lead to the depletion of foreign
exchange reserves, changes in currency values, and adjustments in economic
policies to restore balance.

Imbalance:
• Definition: Imbalance refers to a lack of symmetry or equality between different
components of the balance of payments, such as a trade imbalance, a current
account imbalance, or an imbalance in capital and financial flows.
• Causes: Imbalances can result from trade deficits or surpluses, unequal flows of
financial investments, variations in income from abroad, or discrepancies in the
levels of foreign aid and transfers.
 • Implications: Imbalances may impact a country's economic stability, influence its
currency value, and necessitate policy adjustments to address the underlying issues.

Example: Consider a country called XYZ:

• Disequilibrium Scenario:
• Current Account Deficit: $20 billion (more payments for imports and services
than receipts from exports and services)
• Financial Account Surplus: $15 billion (inflow of foreign investment exceeds
outflow)
• Overall Balance of Payments: -$5 billion (disequilibrium)

In this scenario, XYZ is experiencing a disequilibrium in its balance of payments. The country has
a current account deficit, indicating that it is spending more on imports and services than it is
earning from exports and services. However, the financial account surplus suggests that there is a
net inflow of foreign investment, which partially offsets the current account deficit. The overall
balance is negative, indicating an imbalance between the different components of the balance of
payments.
Addressing such disequilibrium might involve policy adjustments, such as implementing measures
to boost exports, reducing import dependency, attracting more foreign investment, or
implementing monetary and fiscal policies to stabilize the economy.
Understanding and addressing disequilibrium and imbalances are crucial for maintaining a stable
and sustainable economic position in the global context.

Causes and Remedies of Disequilibrium & Imbalance of Payments:

Causes of disequilibrium and imbalance of Payments:

1. More demand of consumption goods:

When demand for consumption goods increases like when population increases or production
decreases, the balance of payment becomes disequilibrium.
2. Price Disequilibrium:
Due to inflation and backward technology domestic prices have increased more than the increase
in prices of foreign goods. This has led to an increase in import and decrease in exports. So, this
causes price disequilibrium.
3. Foreign Competition:
When countries shift from the goods imported from one country to different countries due different
reasons like price, quality etc. Then also exports of one country decrease due to foreign
competition.

4. Less growth in exports:

Despite various export promotion schemes, our exports are still less than our imports. Moreover,
the growth rate of exports is less than the growth rate of imports.

5. Population explosion:
Rapid growth of population in countries like Pakistan increases imports and decreases the capacity
for exports. Moreover, whatever is produced extra for export purposes, the same is consumed
within the country. This leads to an adverse BOP position.

Remedies/Measure to correct disequilibrium in the Balance of

Payments:
1. Promotion of Exports:
Promotion of export is the best measure to correct an adverse balance of payments. For this all
taxes on export goods be withdrawn, export industries should be provided new materials and
transport facilities at reduced prices, so that prices of these goods remain low.

2. Increase in Production:
Increase in production will lead to excess of final goods so a country can export the excess of final
goods to different countries.

3. Trade Agreement:
More trade agreements should be done with foreign countries to promote our foreign trade and
exports.

4. Encouragement of foreign investment:

Foreign industries and MNCs are encouraged to invest their capital in Pakistan. Special facilities
are provided to attract foreign capital. It leads to an inflow of foreign capital.

5. Attraction to foreign tourists:

The government should spend a lot of money to develop picnic spots and resorts in different parts
of the country. A large amount of foreign exchange can be earned from foreign tourists.

6. Devaluation of Pakistan Currency:

Lowering the value of the domestic currency in terms of foreign currency in terms of foreign
currency in terms of foreign currencies is called devolution. The exchange rate of the currency
may be reduced by the government. Foreign goods will become costly and local goods will become
cheap. Imports will be cut down and exports will be pushed up.

Concept of Business cycle & phases of Business cycle:

The business cycle is a recurring pattern of expansion and contraction in economic activity over
time. It reflects the fluctuations in real GDP, employment, and other economic indicators. The
business cycle consists of several phases, each characterized by distinct economic conditions. The
typical phases are:

1. Expansion (Recovery):
• Characteristics:
• Rising economic activity.
• Increasing employment and income.
• Growing consumer and business confidence.
• Higher investment and spending.
• Causes:
• Positive business sentiment.
• Low-interest rates.
• Increased consumer spending.
• Implications:
• Businesses expand production.
• Employment levels rise.
 • Inflation may start to increase.

2. Peak:
• Characteristics:
• Economic activity at its highest.
• Maximum employment.
• High consumer and business confidence.
• Potential inflationary pressures.
• Causes:
• Full capacity utilization.
• Increased investment and speculation.
• Potential overheating of the economy.
• Implications:
• High inflation risks.
• Tight labor markets.
• Possible asset bubbles.

3. Contraction (Recession or Downturn):

• Characteristics:
• Declining economic activity.
• Rising unemployment.
• Reduced consumer and business confidence.
• Falling investment and spending.
• Causes:
• Economic imbalances.
• High-interest rates.
• Reduced consumer spending.
• Implications:
• Businesses cut back production.
• Rising unemployment.
 • Falling income and spending.

4. Trough:
• Characteristics:
• Lowest point in economic activity.
• High unemployment.
• Low consumer and business confidence.
• Bottoming out of investment and spending.
• Causes:
• Correction of imbalances.
• Stimulative monetary and fiscal policies.
• Improved business and consumer sentiment.
• Implications:
• Opportunities for recovery.
• Possibility of policy interventions.
• Potential for economic restructuring.
The business cycle is a natural part of market economies, driven by a combination of external
shocks, policy responses, and inherent economic dynamics. Various factors contribute to the
cyclical nature of the economy, including changes in consumer and business sentiment, monetary
policy decisions, fiscal policies, technological advancements, and global economic conditions.
Governments and central banks often use monetary and fiscal policies to manage the business
cycle, aiming to stabilize the economy and mitigate the negative impacts of recessions while
preventing overheating during expansions. Understanding the phases of the business cycle is
crucial for businesses, policymakers, and investors to make informed decisions based on the
prevailing economic conditions.

Causes of Business cycle & Introduction of theories of trade cycle:

Causes of the Business Cycle:
1. Demand Shocks:
• Boom: A sudden increase in consumer and business demand, often triggered by
factors like low-interest rates, increased consumer confidence, or government
stimulus.
 • Bust: A sudden decrease in demand, leading to a contraction in economic activity.
This can result from factors like high-interest rates, reduced consumer confidence,
or fiscal tightening.
2. Supply Shocks:
• Positive Supply Shock: An increase in productivity or a sudden increase in the
availability of key resources, leading to economic expansion.
• Negative Supply Shock: A decrease in productivity or disruptions in the supply
chain, leading to economic contraction.
3. Financial Shocks:
• Credit Expansion: Rapid growth in credit and lending can fuel economic
expansion.
• Credit Crunch: A sudden contraction in credit markets, often triggered by a
financial crisis, leading to economic contraction.
4. Technological Changes:
• Innovation: Technological advancements can lead to increased productivity and
economic growth.
• Obsolete Technologies: Disruptions caused by the replacement of old technologies
can lead to economic downturns in specific sectors.
5. Government Policies:
• Monetary Policy: Central banks may adjust interest rates, affecting borrowing
costs and, consequently, spending.
• Fiscal Policy: Government decisions on taxation and spending can influence the
business cycle.
6. Global Economic Factors:
• International Trade: Changes in global demand for a country's exports or imports
can impact economic activity.
• Global Financial Conditions: Events like financial crises or economic slowdowns
in major economies can have ripple effects.

Introduction to Theories of Trade Cycle:

Several economic theories attempt to explain the causes and dynamics of the business cycle. Some
prominent theories include:
 1. Keynesian Theory:
• Key Insights: Proposed by John Maynard Keynes, this theory emphasizes the role
of aggregate demand in driving economic fluctuations. According to Keynes,
changes in consumer and business confidence, investment, and government
spending play crucial roles in shaping the business cycle. Government intervention,
through fiscal policy, can be used to stabilize the economy during downturns.

2. Monetarist Theory:
• Key Insights: Associated with economists like Milton Friedman, the monetarist
theory attributes fluctuations in the business cycle to changes in the money supply.
According to monetarists, variations in the money supply affect interest rates,
which, in turn, impact aggregate demand and economic activity. Monetary policy
is seen as a key tool for stabilizing the economy.

3. Real Business Cycle Theory:

• Key Insights: This theory emphasizes real shocks to the economy, such as changes
in technology and productivity. According to real business cycle theorists,
fluctuations in the business cycle are primarily driven by real factors affecting the
production side of the economy. Government interventions are often seen as less
effective in this framework.
It's important to note that these theories often complement each other, and the business cycle is a
complex phenomenon influenced by multiple factors. Different economic schools of thought
provide diverse perspectives on the causes and appropriate policy responses to business cycle
fluctuations.