What Is the Importance of Productivity on the Balance of Payments on the Current Accounts?

What is the importance of productivity on the balance of payments on the current accounts?

Productivity is the measure of output from a production process, per unit of input. For example, labor productivity is typically measured as a ratio of output per labor-hour, an input. In this essay I will explain the importance of productivity on the balance of payments current account, which is defined by exports minus imports (X-M). I will also suggest methods of increasing productivity in an economy.

An increase in the Production Possibility Boundary (PPB) can be achieved by increasing any of the 4 factors of production (Land, Labour, Enterprise and Capital). For example, an increase in the amount of workers available in the economy would allow the PPB curve to shift to the right as more capital and consumer goods can be produced in a shorter space of time. Another example is that if there are advances in science and technology that enable less time consuming production, there will be another shift in the PPB to the right.

The graph shows that an increase in productivity would mean that there would be less inflation, LRAS shifts to LRAS1, whereas AD stays the same. The fall from PL falls to PL1 shows that there is less inflation, and therefore this would improve the balance of payments as the goods are now cheaper, therefore, people will buy more of the county's goods as they are cheaper than buying imports, they will also be exporting more, as their low prices means that other countries can buy cheaper goods from them. Thus, increasing (X-M) and improving the current accounts. This means that it will weaken the power of the pound as exports are now cheaper and imports are more expensive. Also, output increases from Y to Y1 which shows an increase in output as the firms are now being more efficient with their production, and therefore producing more goods.

On the other hand, when analysing the effect this decrease in price will have on aggregate demand, we will see that people are now going to buy more goods, due to the fall in price level, thus, increasing consumption. The AD curve will shift to the left even further, due to the improved balance of payments. This is because AD is calculated by Consumption (C) + Investments (I) + Government Spending (G) + [Exports (X) - Imports (I)]. This increase in aggregate demand will mean that the price level will, once again, rise, leading to increased inflation. However, this may not be the case, depending on the elasticity of the curves. An increase in AD would illustrate rapid growth in the economy.

However, if two competing countries both go through this phase of increased productivity,