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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

Application of nanotechnology in medicine
what is variations in raman spectra for nanomaterials
Jyoti Reply
I only see partial conversation and what's the question here!
Crow Reply
what about nanotechnology for water purification
RAW Reply
please someone correct me if I'm wrong but I think one can use nanoparticles, specially silver nanoparticles for water treatment.
Damian
yes that's correct
Professor
I think
Professor
what is the stm
Brian Reply
is there industrial application of fullrenes. What is the method to prepare fullrene on large scale.?
Rafiq
industrial application...? mmm I think on the medical side as drug carrier, but you should go deeper on your research, I may be wrong
Damian
How we are making nano material?
LITNING Reply
what is a peer
LITNING Reply
What is meant by 'nano scale'?
LITNING Reply
What is STMs full form?
LITNING
scanning tunneling microscope
Sahil
how nano science is used for hydrophobicity
Santosh
Do u think that Graphene and Fullrene fiber can be used to make Air Plane body structure the lightest and strongest. Rafiq
Rafiq
what is differents between GO and RGO?
Mahi
what is simplest way to understand the applications of nano robots used to detect the cancer affected cell of human body.? How this robot is carried to required site of body cell.? what will be the carrier material and how can be detected that correct delivery of drug is done Rafiq
Rafiq
if virus is killing to make ARTIFICIAL DNA OF GRAPHENE FOR KILLED THE VIRUS .THIS IS OUR ASSUMPTION
Anam
analytical skills graphene is prepared to kill any type viruses .
Anam
what is Nano technology ?
Bob Reply
write examples of Nano molecule?
Bob
The nanotechnology is as new science, to scale nanometric
brayan
nanotechnology is the study, desing, synthesis, manipulation and application of materials and functional systems through control of matter at nanoscale
Damian
Is there any normative that regulates the use of silver nanoparticles?
Damian Reply
what king of growth are you checking .?
Renato
What fields keep nano created devices from performing or assimulating ? Magnetic fields ? Are do they assimilate ?
Stoney Reply
why we need to study biomolecules, molecular biology in nanotechnology?
Adin Reply
?
Kyle
yes I'm doing my masters in nanotechnology, we are being studying all these domains as well..
Adin
why?
Adin
what school?
Kyle
biomolecules are e building blocks of every organics and inorganic materials.
Joe
anyone know any internet site where one can find nanotechnology papers?
Damian Reply
research.net
kanaga
sciencedirect big data base
Ernesto
Introduction about quantum dots in nanotechnology
Praveena Reply
hi
Loga
what does nano mean?
Anassong Reply
nano basically means 10^(-9). nanometer is a unit to measure length.
Bharti
Equilibrium price is a stable price and it must stay.discuss
Elvis Reply
Card 14 / 21: What are the similarities between a consumer’s budget constraint and society’s production possibilities frontier, not just graphically but analytically?
Ali Reply

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Source:  OpenStax, Principles of macroeconomics for ap® courses. OpenStax CNX. Aug 24, 2015 Download for free at http://legacy.cnx.org/content/col11864/1.2
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