Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

Student Price: Contact us to learn more

Principles of Economics will allow you to learn a new set of tools to use in personal, professional, business, and political decision making.

This content has been used by 3,587 students

What is a Top Hat Textbook?

Top Hat has reimagined the textbook – one that is designed to improve student readership through interactivity, is updated by a community of collaborating professors with the newest information, and accessed online from anywhere, at anytime.


  • Top Hat Textbooks are built full of embedded videos, interactive timelines, charts, graphs, and video lessons from the authors themselves
  • High-quality and affordable, at a significant fraction in cost vs traditional publisher textbooks
 

Key features in this textbook

Our Principles of Economics Textbooks extend beyond the page with interactive graphing tools, real-world news clips and articles that relate to current events and examples that are relevant to millennial audiences.
Our Principles of Micro and Principles of Macro textbooks can be adopted together or separately, giving you the flexibility to customize your course.
Question bank is available with every chapter for easy quiz and test creation.

Comparison of Principles of Economics Textbooks

Consider adding Top Hat’s Principles of Economics textbook to your upcoming course. We’ve put together a textbook comparison to make it easy for you in your upcoming evaluation.

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Pricing

Average price of textbook across most common format

Up to 40-60% more affordable

Lifetime access on any device

$130

Hardcover print text only

$175

Hardcover print text only

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Content meets standard for Introduction to Anatomy & Physiology course, and is updated with the latest content

In-Book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

Explore this textbook

Read the fully unlocked textbook below, and if you’re interested in learning more, get in touch to see how you can use this textbook in your course today.

Chapter 27: Trade Deficits

Figure 27.1: Image showing the density of commercial shipping routes worldwide. The world volume of trade continues to grow. [1]

False Alarms on the Trade Deficit

​“An alarmist consensus is emerging among economic forecasters and commentators that the U.S. trade deficit in 1998 and 1999 will ‘soar,’ ‘surge,’ and reach ‘extreme levels.’ Prudent observers should treat this consensus, like others arrived at by economic forecasters, with a healthy degree of skepticism. In the present case, even if the forecast of a soaring U.S. trade deficit were closer to the mark than it is likely to be, its limited significance would not warrant the alarm that commentators are sounding. The reason is that the trade deficit is one of the least significant indicators of the economy's vitality and health.”

                          Charles Wolf Jr., Wall Street Journal, March, 5, 1998 [1]

The Huge January Trade Deficit Shows Trump's Hard Job Ahead

“The trade deficit rose 9.6 percent in January, to the highest level since 2012 (though it remains lower as a share of the total economy). It’s in the details of that $48.5 billion gap between what the United States exported and what it imported, though, that you see why the economy is more complex than the “trade deficits are bad” framing of the Trump administration.”

                                                                                                                                        New York Times, March 7, 2017 [2]

ECN27_figure27.2_updated.jpg
Figure 27.2: Net exports of goods and services are shown as a percent of gross domestic product.

​Germany sells autos to Finland, which sends mobile phones to France, which peddles perfume to Italy, which ships olive oil to Belgium, which sells lace to Germany.

If this were all that were to happen, Germany has a trade deficit with Belgium, but a surplus with Finland; France has a deficit with Finland, but a surplus with Italy; Italy has a deficit with France and a surplus with Belgium. The quotes above question a concern with rising trade deficits. Are any of these deficits (or surpluses) with Germany, Finland, and Belgium undesirable? What do you think?

27.1​ Objectives

After completing this chapter, students will be able to:

  • ​Define the balances of trade, current account, and financial account
  • Explain why the current and financial accounts should sum to zero
  • Discuss how changes in GDP affect the balance of trade and how changes in the balance of trade will affect GDP
  • Discuss the myths and issues surrounding the balance of trade deficits

27.2​ International Transactions Accounting

The balance of payments is a set of financial records summarizing our exports and imports, our international investment activity, and flows of funds across our borders. A corporation keeps accounting records on what it sells and buys as well as what it does with the difference. Governments keep records for the entire economy on essentially the same thing, but for international transactions. The accounting has several parts, and we will introduce each one at a time.

27.2.1​ Balance of Trade

Each year, we export goods and services such as automobiles, grain, banking, insurance, and television shows, and we import goods and services like French wine, Japanese automobiles, Italian clothing, and travel.

ECN27_table27.1_updated.jpg
Table 27.1: Balance of Trade, 2018.

The value of exports minus the value of imports is commonly referred to as the balance of trade. In 2018, it looked like Table 27.1. Row seven in Table 27.1 is at different times called the trade balance, the international balance of goods and services, or net exports.

The signs on the numbers represent the direction of the money flows. In 2018, the U.S. exported $2,500 billion of goods and services, that is, we sent goods and services abroad in exchange for $2,500 billion in dollars or other currencies. On the accounting records, we count the money flowing into the country as a positive number.

​Over the same year, we imported $3,122 worth of goods and services. In exchange, we sent $3,122 worth of dollars and international currency to individuals and business abroad. Since funds flowed out of the country, we count that as a negative number.

On balance, we sent more money out then we received. As a result, we incurred a “deficit” in our balance of trade, meaning that we imported more than we exported or alternatively we sent more dollars abroad than we received back from abroad. When we first introduced the concept of GDP, we defined a trade deficit as negative net exports. This is no different.

Question 27.01

The balance of trade is:

A

The difference between the value of our exports and the value of our imports

B

The sum of the value of our exports and the value of our imports

C

Only the value of our exports

D

The value of our net exports

Question 27.02

A balance of trade surplus occurs when:

A

The value of exports minus the value of our imports is negative

B

The sum of the value of exports and the value of our imports is positive

C

The value of exports is smaller than the value of imports

D

The value of net exports is positive

Question 27.03

The balance of trade is in a deficit if:

A

The value of our exports minus the value of our imports is negative

B

The sum of the value of our exports and the value of our imports is positive

C

The value of our exports is larger than the value of our imports

D

The value of our net exports is positive

Question 27.04

Given the data in the following table, find the Balance of Trade (in billions of dollars)

question description
A

$5000

B

$2000

C

-$5000

D

-$1000

E

$1000

27.2.2​ The Current Account

ECN27_table27.2_updated.jpg
Table 27.2: U.S. current account balance.

Businesses and individuals earn income on financial and capital investment, including those they make outside the United States. In 2018, international investments abroad owned by U.S. businesses and individuals earned $1060 billion (line 8 in Table 15.2). Businesses and individuals living in other countries make investments here, and those past investments earned those investors $816 billion in income (line 9 in Table 27.2). Those investment incomes are flows into the country of $1060 billion and out of the country of $816 billion.

​In addition, U.S. individuals and the U.S. government made gifts and transfer payments to individuals and governments abroad that amounted to $110 billion more than individuals and governments abroad sent here in 2018. The balance of payment accounting system adds these flows of payments, called unilateral transfers, to our export and import accounts. Spending and income that come into the country are represented as positive numbers, and spending and income that flow out are represented as negative numbers. This is the same way we treated exports (a plus means that money is flowing in) and imports (a minus means money is flowing out).

​When we put together exports sold, imports bought, investment income earned and paid, and unilateral transfers received and paid, we get the current account balance. it is called the current account because it represents current spending and income and excludes longer-term real and financial investments that are intended to generate future income. The important point to remember is that most of the current account is made up of exports and imports of goods and services. The balance on the current account is normally close to the balance of trade.

Question 27.05

Based on the following table of the current account, determine the value of the trade balance.

question description
A

-100

B

-200

C

+100

D

+200

E

+300

Question 27.06

Based on the following table of the current account, determine the value of the balance of the current account.

question description
A

-100

B

-300

C

-400

D

-500

E

+500

Question 27.07

Question 27.07

The U.S. has experienced a large and often growing trade deficit and current account deficit since 1975. What happens to currency flows as a result? That is, what is happening to flows of U.S. dollars in and out of the U.S.? What is happening to flows of international currencies in and out of the U.S.?

Click here to see the hint to Question 27.07.
Click here to see the answer to Question 27.07.

​What does it mean that in 2016 the U.S. had a $452 billion dollar current account deficit? Individuals, businesses, and governments abroad were net recipients of $452 billion of currency and checking account deposits from the U.S. Some of that amount may actually be U.S. dollars. The other part will consist of international currencies that individuals, businesses, and governments had in the U.S. The easiest way to think about the relationships is to assume that all those payments were made with U.S. dollars. What do the individuals, businesses, and governments abroad want with that currency and those deposits?

Figure 27.3: The flow of money and goods.​​

Some of those abroad will use the dollars they receive to buy U.S. financial assets like stocks, bonds, and bank accounts. Others will simply keep the currency. In some South American and eastern European countries, and in parts of Russia, U.S. currency is used to buy and sell goods and services on a daily basis. Others of those dollars will be used to buy capital assets, real estate, and other longer-term investments in the U.S. Rockefeller Center in New York was sold years ago to a Japanese conglomerate. Honda, Toyota, BMW, and Mercedes-Benz have all built large manufacturing plants in the U.S. China has purchased substantial amounts of U.S. Treasury securities. All of those are increases in the international ownership of U.S. assets. In other words, our current account deficit is paid for through net sales of U.S. assets to businesses, individuals, and governments abroad. Those assets include stocks, bonds, corporations, real estate, U.S. Treasury bonds, and even bank deposits and U.S. and international currencies.

ECN27_table27.3_updated.jpg
Table 27.3: U.S. Balance of Payments (Billion of Dollars) 2018.

One way to think of this increased international ownership of U.S. assets is that it represents what happens to all of the $480 billion sent abroad as a result of our current account transactions. It is, basically, the financial account balance. The financial account balance, then, will equal $480 billion (or – current account balance). But the financial account shows more detail. Individuals and businesses in the U.S. regularly buy financial assets and make investments abroad. Businesses and individuals abroad continually make investments here. So it is the net flows of funds in the financial account that equals the $452 billion sent abroad as a result of current account transactions.

Line 12 in Table 27.3 shows that U.S. individuals and businesses sent $301 billion abroad to buy international stocks, bonds, and bank accounts and to make investments. Line 13 shows that individuals and businesses in other countries sent $801 billion here to buy stocks and bonds or to open bank accounts and to make investments. If they keep the U.S. currency for their own use, it is treated as an increase in international ownership of U.S. assets (which it is – they own U.S. currency). Finally, U.S. and international investors engaged in financial derivatives contracts that resulted in $20 billion in funds flowing out of the U.S.

​These three numbers should add up to a positive $480 billion. That is, the positive balance on the financial account plus the current account balance (which is negative) should equal zero. However, our international transaction accounting is inaccurate. In 2018, the sum of the current account balance and financial account balance was -$8 billion. The statisticians call that difference a “statistical discrepancy.” Government and academic statisticians are simply not able to record all of the millions of international transactions among individuals, businesses, and governments accurately.

Table 27.4: Balance of payment definitions and relationships​​.

​In the U.S. Bureau of Economic Analysis Table of International Transactions, there is one additional, very small item called the capital account. It is so small that it does not materially affect the discussion in this chapter, so we left it out. It contains financial flows that come from non-market activities and do not occur on a regular basis.

Question 27.08

Which of the following best describes the relationship between the current account and the financial account balances?

A

If the financial account is in surplus, the current account must be in surplus.

B

If the financial account is in a deficit, the current account must be in a deficit.

C

There is no direct relationship between the current account and financial account.

D

The balance on the financial account will equal the balance on the current account with the opposite sign.

Question 27.09

Given the following table, find the current account balance.

question description
A

-100

B

-400

C

-700

D

500

E

-200

Question 27.10

Given the following table, find the financial account balance.

question description
A

-100

B

-400

C

-700

D

500

E

-200

Question 27.11

Based on the following table of the balance of payments, determine the value of the statistical discrepancy.

question description
A

-100

B

-200

C

+100

D

+200

E

-500

Question 27.12

If a U.S. firm purchases a service from the European Union, and the EU firm uses the proceeds to buy a U.S. government bond, then the U.S. net exports ______________ and the net inflow of money ______________.

A

Fall, rises

B

Fall, falls

C

Rise, falls

D

Rise, rises

Question 27.13

If a Chinese firm sells a product in the U.S. and then uses the proceeds to buy stocks from a U.S. firm, then Chinese net exports ______________ and China is ______________ the U.S.

A

Increase, lending to

B

Decrease, borrowing from

C

Increase, borrowing from

D

Decrease, lending to

Question 27.14

Indicate where, if at all, the following should appear in the balance of payments. Match the entries in the right column with entries in the left column.

Premise
Response
1

A resident of the U.S. opens a bank account in Kuala Lumpur¸ Malaysia

A

Internationally-owned assets in U.S. increase (inflow of money)

2

A Korean company builds a new factory in the U.S.

B

U.S.-owned assets abroad increase (money outflow)

3

A U.S. consumer buys a Toyota made by a Japanese-owned company in South Carolina

C

Imports of goods (money outflow)

4

A college student spends the fall semester in Hungary

D

Imports of goods and services (money outflow)

5

Apple brings hard drives from its own factory in China to Wisconsin to be placed in Apple laptops to be sold in the U.S.

E

Not included. Part of U.S. production


27.3​ Costs and Benefits of Trade Deficits

ECN27_figure27.4_updated.jpg
Figure 27.4 U.S. net exports over time.


Question 27.15

Question 27.15

Given the above figures, explain how it is possible for the net exports to fall while both components of it are rising.

​Hover here to see the hint for Question 27.15.
​Click here to see the answer to Question 27.15.

In the 1960s, we generated considerable surpluses in net exports, but since 1975, we have had large international trade deficits. The trade surpluses in the 1960s were not as large in an absolute sense as recent deficits. In the 1980s, the trade deficits increased significantly and peaked in 1987 at more than three percent of the economy. They begin to decrease as percentages of GDP until 1992, then increase again in the 1990s, eventually reaching an even higher peak of 5.7 percent in 2005 and 2006. They have declined slightly since.

Table 27.5: Headlines about the U.S. trade deficits are common.​

​The U.S. Trade Deficit is a Good Thing. Really. [4]

                                                                                   -The Washington Post, August 4, 2017

U.S. Trade Gap Edges Up; Deficit with China at 11-month high [5]

                                                                                       -CNBC, September, 5, 2017

U.S. Trade Deficit Shrank in August as Exports Rose [6]

                           -New York Times, October 5, 2017


  The Trade Deficit Isn’t a Scorecard, and Cutting It Won’t Make America Great Again [7]

"Donald Trump believes that a half-trillion-dollar trade deficit with the rest of the world makes the United States a loser and countries with trade surpluses like China and Mexico winners.

“They’re beating us so badly,” he has said. “Every country we lose money with.”

The reality is different. Trade deficits are not inherently good or bad; they can be either, depending on circumstances. The trade deficit is not a scorecard." [...]

               -Neil Irwin for the New York Times, The Upshot , March 27, 2016

​The article above makes two important points. First, we benefit from international trade, even if we run a trade deficit. U.S. consumers get to enjoy products and services from all over the world that would otherwise be unavailable or too expensive if not for trade with the rest of the world. A trade deficit means that the U.S. is getting more goods and services from abroad than we are sending abroad. If that were the end of the story and if (that’s a big if) it could do so forever, it is not obviously such a bad thing.

The second point is that there is the flip side to a trade deficit. As we discussed earlier in this chapter, a trade deficit means that we also will have a surplus on our financial account. A trade deficit means that individuals and businesses abroad will own more U.S. stocks, bonds, bank accounts, real estate, capital investment, and currency. It really means that we are giving up those assets to get current imports.

A trade deficit is very much like borrowing. We are getting current goods and services in exchange for pieces of paper that entitle the owners of those pieces of paper to future goods and services. So part of the answer to whether a trade deficit is good or bad depends upon how we use the corresponding financial account surplus. If we financial account flows to expand our productive capacity, then we will be able to produce more in the future and easily pay back those “loans” if necessary. If we are using the excess imports for consumption, we are really trading future consumption for current consumption.

ECN27_table27.6_updated.jpg
Table 27.6: Annual Average Percent of Real GDP.

​In an earlier chapter, we discussed what has happened to private and public saving, investment, and net exports over the last several decades. Those data are shown again in Table 27.6.

From the first period to the second, our federal budget deficit increased and we saved less. This means that national savings (private savings minus the federal deficit) has fallen. At the same time, private investment stayed the same and we were getting more goods from abroad. So generally, it appears that we are using the financial account surplus (a rising trade deficit) for more consumption and to finance the larger federal budget deficit. (The data in the table do not add exactly due primarily to the challenges of collecting exact international trade and financial flows.)

Question 27.16

In a small open economy, if exports equal $50 billion, imports equal $30 billion, and domestic national saving equals $25 billion, then we are ______________ individuals and businesses abroad and have a trade ______________:

A

Lending $20 billion to, surplus

B

Borrowing $20 billion from, deficit

C

Lending $25 billion to, surplus

D

Borrowing $55 billion from, deficit

E

Borrowing $5 billion from, surplus

Question 27.17

Question 27.17

Does it make a difference whether we have deficits or surpluses with individual countries?

Hover here to see the hint for Question 27.17.​
Click here to see the answer to Question 27.17.

Question 27.18

Question 27.18

Explain the relationship between saving in the U.S. and the trade deficit.

​Hover here to see the hint for Question 27.18.
Click here to see the answer to Question 27.18.

Question 27.19

A trade deficit is paid for by all of the following except by:

A

Borrowing from international governments

B

Borrowing from international individuals

C

Selling real and financial domestic assets to international governments

D

Borrowing from domestic savers

Question 27.20

The value of net exports is also the value of:

A

Net saving

B

Private saving

C

Net investment

D

National saving

E

Excess national saving over domestic investment

Question 27.21

When we are borrowing from international governments, businesses, and individuals, then:

A

Imports must be positive

B

Exports must be positive

C

Trade balance must be positive

D

Net exports must be negative

Question 27.22

In a small open economy if domestic private saving equals $50 billion, government saving equals -$20 billion, the trade balance is -$20 billion then

A

Domestic investment equals $50 billion and we are in a trade deficit

B

Domestic investment equals $30 billion and we are in a trade deficit

C

The government budget is in a surplus of $20 billion

D

If the government budget deficit is lowered then domestic investment would decrease.

Question 27.23

If domestic government budget surplus is greater than domestic investment, then the trade balance is in ______________ and the trade balance is ______________ than private saving (assuming private saving is positive).

A

Surplus, greater

B

Surplus, smaller

C

Deficit, greater

D

Deficit, smaller

Question 27.24

If exports equal $80 billion, imports equal $50 billion, and private plus public saving equals $10 billion, then we are in a trade ______________ and we are probably ______________ international businesses and individuals.

A

Surplus, lending $30 billion to

B

Surplus, borrowing $30 billion from

C

Deficit, lending $10 billion to

D

Surplus, borrowing $10 billion from

Question 27.25

In a small open economy, if the budget deficit increases, then which is likely to be accurate?

A

If private saving stays the same and net exports increases, then domestic investment rises.

B

If private saving and domestic investment stay the same, then the trade balance decreases.

C

If domestic investment falls by the same amount as the government saving, and net exports also fall then domestic saving could remain the same.

D

Net exports could stay the same if either domestic investment increases or private savings decreases or both happen at the same time by the same amount as the fall in public saving.

Question 27.26

If a small open economy has a balanced government budget, then which of the following is likely to occur?

A

It must also have balanced trade.

B

Private domestic saving must be equal to domestic investment.

C

If there is a trade surplus, then domestic investment is less than domestic private saving.

D

If there is a trade deficit, then domestic investment is less than domestic private saving.

Question 27.27

If in a small open economy both the government budget and international trade are in balance, which of the following is accurate?

A

Public saving is positive.

B

Domestic Investment is greater than national saving.

C

Domestic investment equals private domestic saving.

D

If domestic private saving increases then domestic investment in productive capacity decreases.

27.4​ The Relationship Between Real GDP and Net Exports

The Huge January Trade Deficit Shows Trump’s Hard Job Ahead [8]

"President Trump says that the U.S. persistent trade deficit is a scourge that must be eliminated. But new data Tuesday shows the complexity of the costs and benefits of trade – and how reducing the trade deficit, if not done right, could leave Americans worse off.

What really matters is not whether the trade deficit is rising or falling. What matters is why."

                                                                                                   -Neil Irwin for the The New York Times, March 7, 2017

Several times earlier in the text, we have discussed the importance of understanding the direction of causation. Here it is, important once again.

Table 27.7: The direction of causation between GDP and Net Exports goes both ways.​

​Scenario A shows what happens if net exports decrease first. If that happens, the decline in net exports will cause a multiplied decrease in total spending and real GDP. Net exports and real GDP move in the same direction.

However, in scenario B, the causation is the reverse and the relationship between real GDP and net exports is the opposite. Real GDP increases for some unrelated reason. That causes income to increase. As our income increases, consumption rises, and part of consumption, for most of us, is spent on imports. Our imports rise and net exports fall. This time, with real GDP changing first, real GDP and net exports move in opposite directions.

​Is the New York Times paragraph above referring to scenario A or scenario B? Apparently, it refers to both, because it is saying that the rise in the deficit “may signal” a recession. The explanation that follows implies that the increasing deficit may cause a slowdown in the economy, as exports fall. Exports are part of the total spending on our production by international businesses and people abroad. However, it may be a signal that because domestic spending and output are rising, there is a fall in net exports.

Question 27.28

Will a rising trade deficit be a cause of slowing growth in the U.S. economy?

A

It could be that the rising deficit will cause an increase in real GDP.

B

It could be that the rising deficit will cause a decrease in real GDP.

C

A rising deficit cannot by itself cause a recession.

D

In reality, a fall in net exports is a likely cause of most recessions.

Question 27.29

Which of the following sequences of events is accurate?

A

Exports increase → net exports fall → total spending falls → real GDP falls

B

Exports increase → net exports rise → total spending falls → real GDP falls

C

Exports increase → net exports rise → total spending rises → real GDP rises

D

Exports decrease → net exports fall → total spending rises → real GDP rises

Question 27.30

Ignoring the effects on prices, which of the following sequences of events is accurate?

A

Aggregate demand increases → real GDP rises → imports fall → net exports increase

B

Aggregate demand increases → real GDP rises → imports rise → net exports increase

C

Aggregate demand increases → real GDP rises → imports rise → net exports decrease

D

Aggregate demand increases → real GDP falls → imports rise → net exports decrease

Question 27.31

Trade deficits may be considered to be undesirable if we use the deficits to:

A

Consume more in the future

B

Increase domestic investment

C

Consume more now

D

Expand our productive capacity

Question 27.32

Deficits are considered good if we use:

A

Excess imports for consuming more now

B

Excess imports to run government budget deficits

C

It so we can save less and consume more today

D

It to expand our productive capacity

Question 27.33

Which of the following sequences of events is accurate?

A

Exports decrease → net exports rise → total spending falls → real GDP falls

B

Exports increase → net exports rise → total spending rises → real GDP falls

C

Exports increase → net exports rise → total spending rises → real GDP rises

D

Exports decrease → net exports fall → total spending rises → real GDP rises

Question 27.34

Ignoring changes in prices, which of the following sequences of events is accurate?

A

Aggregate demand falls → total income rises → imports fall → net exports fall

B

Aggregate demand rises → total income rises → imports rise → net exports fall

C

Aggregate demand rises → total income rises → imports rise → net exports rise

D

Aggregate demand falls → total income falls → imports fall → net exports rise

Question 27.35

Which of the following sequences of events is accurate? Focus on the effects of European price changes alone. A rise in overall spending in Europe will cause which of the following in the U.S.?

A

U.S. exports and imports will rise. We cannot tell about U.S. real GDP.

B

U.S. exports rise and imports will decline. U.S. real GDP increases.

C

U.S. exports decline and imports will rise. U.S. real GDP decreases.

D

U.S. exports and imports will decline. We cannot tell about U.S. real GDP.

Question 27.36

Which of the following sequences of events is accurate?

A

Consumption falls → real GDP falls → total income rises → imports fall → net exports fall

B

Expansionary monetary policy is implemented → Interest rates fall → real GDP rises → total income rises → imports rise → net exports fall

C

The international economy is booming → international total income rises → U.S. imports rise → net exports rise

D

Exports rise → net exports fall → total spending falls → real GDP falls

27.5​ Summary

  • ​A country’s balance of trade is its net exports. A slightly expanded account that includes flows of profits and incomes among countries is the balance on the current account.
  • The U.S. has a large trade deficit and a deficit in its current account.
  • The balance on the financial account is the flow of investment funds into a country, both in terms of real investment and financial investment minus similar flows out of the country.
  • The balance on the financial account represents increased ownership of financial assets by business and individuals abroad in exchange for the goods and services they send to the U.S. in excess of what individuals and businesses send abroad.
  • Trade deficits that are large and growing as a percentage of a country’s GDP do have costs. The growth in those deficits is not sustainable. Those costs include the future obligation to provide goods and services to other countries, likely higher interest rates, and eventually lower investment and lower economic growth. In extreme cases, there may be an increased likelihood of a financial panic and a subsequent recession.

​27.6 Key Concepts

 ​Balance of payments
 Trade deficits and surpluses
 Balance of trade
 Balance of goods and services
 Current account balance
 Financial account balance
 Relationship between GDP and net exports
 Costs of trade deficits

27.7​ Glossary

Balance of payments: The accounting records for a country’s transactions between its residents and businesses and those of all other countries.

Balance of trade: The difference between the value of our exports and the value of our imports.

Financial account balance: The balance on that part of the balance of payments accounts that includes flows of funds for real and financial investments.

Current account balance: The balance of trade plus the net flow of income earned on investments and unilateral transfers.

Capital account balance: The part of the balance of payments accounts that includes non-market based activities at irregular time intervals that are a small share of the balance of payments. We have excluded it in this discussion.

Trade deficit: Imports exceed exports. It is the same as the balance of trade when that balance is negative.

Trade surplus: Exports exceed imports. It is the same as the balance of trade when that balance is positive.


Locked Content
This Content is Locked
Only a limited preview of this text is available. You'll need to sign up to Top Hat, and be a verified professor to have full access to view and teach with the content.


Answer Keys:

Answer to Question 27.07

If there are more imports than exports, then more U.S. dollars and more international currencies must be flowing out of the U.S than are flowing in. People and businesses abroad end up with more U.S. dollars, and the U.S. has less international currency.

Click here to return to Question 27.07.




Answer to Question 27.15

Net exports are exports minus imports. In the graphs above we can see that both exports and imports are rising, but the gap between them is getting larger since imports are rising faster than exports, so net exports are becoming a bigger negative number, or the gap representing the size of the trade deficit is getting larger. Therefore, it is possible for net exports to decrease while both imports and exports are rising as long as imports are rising faster than exports.

​Click here to return to Question 27.15.






Answer to Question 27.17

It matters little. It is highly unlikely that all countries would have exact matches on their exports and imports with every other country. There are millions of individuals and businesses making independent decisions about how much to buy, and it would be an amazing coincidence if the amount sold to those abroad exactly equaled the amount that people abroad would want to buy. And it really makes little difference. If we had a zero overall trade deficit, it is likely that we would still have deficits and surpluses with individual countries. Go back and read the first paragraph of this chapter.

​Click here to return to Question 27.17.






Answer to Question 27.18

We know that investment equals private saving minus government budget deficit minus net exports. So if households decide to save less while simultaneously running a government budget deficit, either investment must fall, or net exports must rise. Recently, we’ve seen that as the U.S. saving rate has fallen (and the budget deficit has expanded), investment stayed the same, so net exports had to have increased.

​​Click here to return to Question 27.18.


Image Credits:

[1] Image courtesy of Grolltech under CC BY-SA 3.0.

The difference between the value of our exports and the value of our imports. The same as the balance of goods and services and as net exports.
The balance of trade plus the net flow of income earned on investments and unilateral transfers.
When a country exports its goods and services it gets paid in return, and when it imports goods and services it has to pay for them.
The balance on that part of the balance of payments accounts that includes flows of funds for real and financial investments.
Are they increasing at the same rate?
Is it possible to run an overall trade deficit while running a surplus with a single country?
What likely happens to the current account when the US runs a trade deficit?