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Short-term movements in the business cycle and the trade balance

In the short run, trade imbalances can be affected by whether an economy is in a recession or on the upswing. A recession tends to make a trade deficit smaller, or a trade surplus larger, while a period of strong economic growth tends to make a trade deficit larger, or a trade surplus smaller.

As an example, note in [link] that the U.S. trade deficit declined by almost half from 2006 to 2009. One primary reason for this change is that during the recession, as the U.S. economy slowed down, it purchased fewer of all goods, including fewer imports from abroad. However, buying power abroad fell less, and so U.S. exports did not fall by as much.

Conversely, in the mid-2000s, when the U.S. trade deficit became very large, a contributing short-term reason is that the U.S. economy was growing. As a result, there was lots of aggressive buying in the U.S. economy, including the buying of imports. Thus, a rapidly growing domestic economy is often accompanied by a trade deficit (or a much lower trade surplus), while a slowing or recessionary domestic economy is accompanied by a trade surplus (or a much lower trade deficit).

When the trade deficit rises, it necessarily means a greater net inflow of foreign financial capital . The national saving and investment identity teaches that the rest of the economy can absorb this inflow of foreign financial capital in several different ways. For example, the additional inflow of financial capital from abroad could be offset by reduced private savings, leaving domestic investment and public saving unchanged. Alternatively, the inflow of foreign financial capital could result in higher domestic investment, leaving private and public saving unchanged. Yet another possibility is that the inflow of foreign financial capital could be absorbed by greater government borrowing, leaving domestic saving and investment unchanged. The national saving and investment identity does not specify which of these scenarios, alone or in combination, will occur—only that one of them must occur.

Key concepts and summary

The national saving and investment identity is based on the relationship that the total quantity of financial capital supplied from all sources must equal the total quantity of financial capital demanded from all sources. If S is private saving, T is taxes, G is government spending, M is imports, X is exports, and I is investment, then for an economy with a current account deficit and a budget deficit:

Supply of financial capital  =  Demand for financial capital S +  (M – X) = I +  (G – T)  
A recession tends to increase the trade balance (meaning a higher trade surplus or lower trade deficit), while economic boom will tend to decrease the trade balance (meaning a lower trade surplus or a larger trade deficit).

Problems

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?

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[link] provides some hypothetical data on macroeconomic accounts for three countries represented by A, B, and C and measured in billions of currency units. In [link] , private household saving is SH, tax revenue is T, government spending is G, and investment spending is I.

Macroeconomic accounts
A B C
SH 700 500 600
T 00 500 500
G 600 350 650
I 800 400 450
  1. Calculate the trade balance and the net inflow of foreign saving for each country.
  2. State whether each one has a trade surplus or deficit (or balanced trade).
  3. State whether each is a net lender or borrower internationally and explain.

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Imagine that the economy of Germany finds itself in the following situation: the government budget has a surplus of 1% of Germany’s GDP; private savings is 20% of GDP; and physical investment is 18% of GDP.

  1. Based on the national saving and investment identity, what is the current account balance?
  2. If the government budget surplus falls to zero, how will this affect the current account balance?

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Questions & Answers

Demand is the various quantities of goods and services that consumer(s)are willing and able to purchase at a price within a time
Muhammad Reply
What is demand
Mc Reply
Distinguish between cross elasticity and income elasticity of demand
Ruth Reply
Distinguish between cross elasticity and income elasticity of demand
Ruth
if change in the demand of the commodity with respect to change in demand of the substitute or other product called cross elasticity
Hamza
and. if change in the demand of the commodity due to change in the income . called income elasticity
Hamza
👍
Vipul
Cross elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to a small change in price of another commodity whiles Income elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to a small change in income of it's consumers
Afriyie
but these are book wordings
Hamza
income elasticity of demand shows how quantity demanded changes due to changes in income on the other hand cross elasticity refers to how the quantity demanded of a particular good alers given a change in the price of another good.
Keysie
what is the competitive demand
Adiza Reply
Income
Sanni
With regards to coal shortage and manicipal debts the what form of intervention do you think Eskom can put in place.
kedibone Reply
economic growth of Bhutan
Nima Reply
please, explain all the mathematics terms used in economics
nelson
The answer is: little more than high school algebra and graphs.
Tere
what is the effect of inflation in GDP
ahmed Reply
Not only real GDP but also nominal GDP will decrease
Aqib
yep. Inflation has an influence not only GDP but interest rate also.
Hamza
The pound weakens so imports become more expensive and exports lose value - lower GDP.
Rebecca
why do inflation effect economic
Chelsea Reply
explain in detail what is economic what is scarcity what is alternate uses
Ejiro Reply
What is law of demand
Hilary
economic as a science refers to study of human resource
Kaunda
Law of demand- With all the factors remaining same if price increases of a commodity, the quantity of demand of that commodity decreases and vice versa
Dey
Thanks dey sunita
Hilary
What is law of supply
Hilary
what are the factors that affect demand
Elly Reply
what are the factors that affect demand of a good
Elly
what are the factors that affect demand of a good
Elly
what are the factors that affect demand of a commodity
Elly
1. the price of the product 2. the price of other products 3. consumers income 4. expectation of future changes in price 5. taste and preference etc.
ALI
Change in price
Hilary
1. price related of commodities 2. consumers income 3. the condition or season of the commodities
Tsai
decrease in demand of substitute increase in demand of constituent change in quantity and other environmental factors
Hamza
Nd consumer's income
Hamza
what course scarcity
Bashari Reply
Scarcity is the limited availability of a commodity, which may be in demand in the market or by the commons. Scarcity also includes an individual's lack of resources to buy commodities. The opposite of scarcity is abundance.
Marc
Reasons that explain why the division of labor increases an economy's level of production
Chukwuka Reply
Please I don't understand the meaning and the concept of economics as a science
Ophelia Reply
economics as a science refers to the study of human behavior. how they make decisions etc
Saidou
economics is science because it uses scientific methods in analysing societal problems.. observation experimentation and conclusion inherently are used to analyse. however it is not pure science but social science because it studies human and it's environs
Bonney
what's elasticity of demand
Isaac Reply
are u asking because you don't know or what
Stephen
A measure of the responsiveness of a product demanded to a change in market price
Yuusuf
the degree of responsiveness of a product demanded to a little change in the price
Saidou
the degree of responsiveness of quantity demanded of a commodity to the changes in the price if the commodity in question, changes in the price of other related commodities and changes in the income of consumer
Bonney
what is international trade
Kwame Reply
international trade is a trade between foreign country
IYke
it is the exchange of goods and services between countries
Bonney
it's the exchange of goods and services from one foreign country to another
Israel

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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