Question

Suppose the economy of the large country of Hendrix is currently experiencing expansion as a result of short run business cycle fluctuations. Hendrix has a trade deficit. The items below are possible effects of this expansion on the trade balance. Please sort them into boxes below as appropriate. If they do not fit into either box (e.g. not likely to occur in an expansion), leave them unsorted.

Likely to occur in an expansion and increase the trade deficit
Likely to occur in an expansion and decrease the trade deficit
private savings decrease domestic private investment increases private savings increase government borrowing decreases imports increase government borrowing increases domestic private investment decreases imports decrease

Answer 1

Likely to occur in an expansion and increase the trade deficit.

• Domestic private investment increases

• Imports increase

As a result of expansion, there is more income in the economy which means that people will be able to invest more. The investment will however lead to more imports as capital goods are acquired. This will therefore increase the trade deficit which is defined as the difference between net exports and net imports.

Likely to occur in an expansion and decrease the trade deficit.

• Private savings increase

• Government borrowing decreases

In an expansion, people will have more income and so will save more. As a result of them not spending these savings on imports, the trade deficit will go down.

Also with the economy in an expansion, the government would not need to borrow as much money to prop up the economy. This will reduce the trade deficit which includes loans from outside.