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By the end of this section, you will be able to:

  • Explain the connection between trade balances and flows of financial capital
  • Calculate comparative advantage
  • Explain balanced trade in terms of investment and capital flows

As economists see it, trade surpluses can be either good or bad, depending on circumstances, and trade deficits can be good or bad, too. The challenge is to understand how the international flows of goods and services are connected with international flows of financial capital    . In this module we will illustrate the intimate connection between trade balances and flows of financial capital in two ways: a parable of trade between Robinson Crusoe and Friday, and a circular flow diagram representing flows of trade and payments.

A two-person economy: robinson crusoe and friday

To understand how economists view trade deficits and surpluses, consider a parable based on the story of Robinson Crusoe. Crusoe, as you may remember from the classic novel by Daniel Defoe first published in 1719, was shipwrecked on a desert island. After living alone for some time, he is joined by a second person, whom he names Friday. Think about the balance of trade in a two-person economy like that of Robinson and Friday.

Robinson and Friday trade goods and services. Perhaps Robinson catches fish and trades them to Friday for coconuts. Or Friday weaves a hat out of tree fronds and trades it to Robinson for help in carrying water. For a period of time, each individual trade is self-contained and complete. Because each trade is voluntary, both Robinson and Friday must feel that they are receiving fair value for what they are giving. As a result, each person’s exports are always equal to his imports, and trade is always in balance between the two. Neither person experiences either a trade deficit or a trade surplus.

However, one day Robinson approaches Friday with a proposition. Robinson wants to dig ditches for an irrigation system for his garden, but he knows that if he starts this project, he will not have much time left to fish and gather coconuts to feed himself each day. He proposes that Friday supply him with a certain number of fish and coconuts for several months, and then after that time, he promises to repay Friday out of the extra produce that he will be able to grow in his irrigated garden. If Friday accepts this offer, then a trade imbalance comes into being. For several months, Friday will have a trade surplus: that is, he is exporting to Robinson more than he is importing. More precisely, he is giving Robinson fish and coconuts, and at least for the moment, he is receiving nothing in return. Conversely, Robinson will have a trade deficit, because he is importing more from Friday than he is exporting.

This parable raises several useful issues in thinking about what a trade deficit and a trade surplus really mean in economic terms. The first issue raised by this story of Robinson and Friday is this: Is it better to have a trade surplus or a trade deficit? The answer, as in any voluntary market interaction, is that if both parties agree to the transaction, then they may both be better off. Over time, if Robinson’s irrigated garden is a success, it is certainly possible that both Robinson and Friday can benefit from this agreement.

Questions & Answers

which model predicted a global collapse in the world's social and economic system before the year 2010
Francis Reply
what is the formula of mixed income ?
Sanjum Reply
labor force in.Nigeria is seen as .......?
Aisha Reply
Is demand the same as being in need of a product?
Aphiwe Reply
yeah
Demand is defer from only need of products
Zubairu
need is the primary and main root of demand. but demand is the result of combination of need; income capacity and desire to expend of money for that product.
Ramu
products or services
jax
what is price determination?
Alick Reply
why are imports subtructed when GDP is calculated in the expenditure approach
nati
what is fiscalpolicy
nati Reply
The way of the government expenses and other analysis
Zubairu
It explains government spending and how it helps to direct the economy towards the desired direction. For instance, if the govt of a nation is desirous of achieving economic growth and development, then the govt will adopt an expansionary fiscal policy which imply more spending by the govt.
Sunday
and politics party important
mujtaba Reply
politics party important
mujtaba
Which party is that
Zubairu
persons who stopped searching for jobs but would accept if the opportunity presents itself
Torissa Reply
persons who are unemployed whether they are underage, retired or incapacitated
Torissa
the us economy is best characterized as?
Shekeriah
what is the impact of fiscal policy in the short and long run in the AD/AS model...
Hydrammeh Reply
What is demand
Mohd Reply
Demand is the desire for a commodity backed by the willingness and the purchasing power too.
Ajay
what is the impact of the higher tax rate on the business and the economy at large..?
Hydrammeh Reply
aggregate demand decreases and GDP decreases in the long run prices will decrease because aggregate supply will shift to the right and increase
Murabit
Thanks, Murabit
Hydrammeh
But still I will need more explanation
Hydrammeh
no problem tax rate is a form of fiscal policy so any time the government changes spending or taxes it will directly affect the economy
Murabit
but remember that there at different economic views on fiscal policy there is classical,Keynesian and moneterism
Murabit
if taxes increase aggregate demand decreases causing a fall in prices causing a fall in the money demand lowering interest rate and increasing investment spending in turn increasing prices
Murabit
thanks so much Murabit
Hydrammeh
what are the policy recommendations for impact of government borrowing?
Baisiro Reply
how can I get Utility notes here
Tabea Reply
I also want to know
konglan
I have them
Alick
money and money supply
Yogesh Reply
money is anything that is generally accepted as payment of goods and services or that is accepted in settlement of debt.
Rakgadi
Money supply?
Rakgadi
Money supply is the total value of monetary assets available in an economy at a specific time.
Rakgadi
supply of money:- The total quantity of money in an economy at a point of time......
Ittoo
What is the difference between monetary economy and barter economy?
Rakgadi
monetary economy is simply an economy where money acts as a medium of exchange and barter economy is why where goods acts as a medium of exchange
Ittoo
Thank you Ittoo.
Rakgadi
please cut why.....in last ans
Ittoo
and no need of thanks dear
Ittoo
Don't damend work in inflation
Mishael Reply

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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