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Chapter 23: Q 28 (page 577)

When is a trade deficit likely to work out well for

an economy? When is it likely to work out poorly?

Short Answer

Expert verified

When the trade deficit is caused by the budget deficit, it might work out poorly.

Step by step solution

01

Step 1. Introduction

As per the Savings-Investment identity,

S + (M – X) = I + (G – T),

or, (M-X)= (I-S) + (G-T)

where,

S- Savings,

M- Imports,

X-Exports,

M-X - Trade Deficit,

I- Investments,

G- Government Expenditure,

T- Taxes

02

Step 2. Explanation

It totally depends upon the savings and investment relationship. whether the trade deficit if is beneficial for an economy or not,

If domestic investments exceed domestic savings, then the country shall undergo a situation of trade deficit, and to finance this there shall be an inflow of financial capital into the economy. This is not necessarily bad. It is so because with more and more investment, the incomes in the future shall rise too.

But, when trade deficit is caused primarily due to the budget deficit, it might not be good for the economy as the government shall borrow and there won't be any income to finance investments.

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Most popular questions from this chapter

State whether each of the following events involves a financial flow to the Mexican economy or a financial flow out of the Mexican economy:

a. Mexico imports services from Japan

b. Mexico exports goods to Canada

c. U.S. investors receive a return from past financial investments in Mexico

What is the difference between trade deficits and balance of trade?

Imagine that the U.S. economy finds itself in the following situation: a government budget deficit of \(100 billion, total domestic savings of \)1,500 billion, and total domestic physical capital investment of \(1,600 billion. According to the national saving and investment identity, what will be the current account balance? What will be the current account balance if investment rises by \)50 billion, while the budget deficit and national savings remain the same?

Why does a recession cause a trade deficit to increase?

In what way does comparing a country’s exports to GDP reflect its degree of globalization?
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