Question

A small open government-less economy’s only production is from a spring that offers particularly tasty and nutritious water. It produces a dependable $100,000 worth of water each year (that can be consumed or exported). In the past, the country has amassed $500,000 worth of foreign bonds that dependably pay 5%/yr ($25,000/yr) and will do so indefinitely. (Such bonds that never mature and are scheduled to keep paying forever are called “consuls”.) If the country decided now to simply consume its GNP from this day forth (i.e., without buying or selling its bond holdings and without using any of that GNP to finance the production of new capital anywhere), what will be its:(a) CA (b) KFA

Answer 1

Current Account Balance or CA is defined as the amount that the country maintains after the amount imported from the foreign countries and external sources is deducted from its balance of payment value.

                    Here, from the details given, the government’s only source of income is the nutritious and tasty water that the country produces, which is worth $100,000. The country had invested on bonds worth $500,000 from a foreign country from which it is earning 5% per year amounting to $25,000 a year, which will continue to be paid to the country. Now, if the Government decides not to invest or utilize the amount of money it generates on any productive investment or Government initiate and simply decides to consume the amounts, its CA will be = $100,000 + $25,000 = $125,000 a year.

                                                KFA for this economy will be negative. This is because KFA of a country decodes what is the status of the country’s imports v/s its exports. i.e. if the countries imports are greater than its exports, KFA is in negative, and of the country’s exports are greater than its imports, KFA is in positive. IN the case of this country, the country is not exporting anything to the foreign country. However, it is getting 5% on the amount invested on bonds on a yearly basis. Therefore the KFA will be negative.