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Income of the nation (Y) or receipt from the expenditure on its final goods and services is Y =C+I+G+X

Absorption A is a nation's total expenditure on domestic final goods and services.

i.e. A = C+I+G+M

And So, Y-A = X-M

Or, B = Y-A, B = current account surplus, if net factor income is zero.

Current Account deficit means absorption exceeds output.

Now, dB = dY-dA

Implies B will be improved only if output increases more to absorption.

Balance of Payment policy instrument can be classified in two segment on the basis of their initial impact on the output or absorption.

In order to change absorption without changing output, a policy must lead to replacement of foreign goods by domestic goods or vice-versa. e.g. devaluation or import restriction. This is expenditure switching policy.

Policies that affect both income and absorption (e.g. fiscal and monetary policy) are expenditure reducing policy

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Q: What is the absorption approach to balance of payments?
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