Causes of a Trade Deficit

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Causes of a Trade Deficit. – 10 Marks

The balance of trade (or net exports) is the difference between the monetary value of exports and imports in an economy over a certain period of time. If a country is importing more than exporting, this is known as a trade deficit. The deficit equals the value of goods being imported minus the value of goods being exported, and it is given in the currency of the country in question. For example, assume that the United Kingdom imports 800 billion British pounds worth of goods, while exporting only 750 billion pounds. In this example, the trade deficit, or net exports, would be 50 million pounds.

There are two parts to the balance of trade: Visible and Invisible Trade. Visible trade refers to tangible goods and in the UK there is a substantial deficit in this sector. Invisible trade refers to trade in goods & services and at the moment in the UK there is a small surplus in this sector.

The causes of a trade deficit can rely on the demand-side of the economy and also the supply-side of the economy.

One of the causes of a trade deficit is competition from low cost manufacturers from other economies. This affects the importing side of things. If there are cheaper goods elsewhere then other countries will import from there. Another cause is competition from countries, which have higher quality goods than competing countries. This is most likely to effect countries in the short run as in the long run quality can be increased and costs can be lowered.

The exchange rate also affects the trade deficit. A strong exchange rate can lead to a deficit depending upon the price elasticity of demand (Marshall learner) If the pound appreciates and the aggregate PED for exports and imports is greater than 1 then deficit would get worse. This is also a short-term factor.

Strong consumer demand also can affect the balance of trade. If real household spending increases more than the supply-side of the economy can deliver, than...
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