Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Balance of Trade

Balance of Trade

The transaction you make when buying Chinese goods from Amazon affects your country's trade balance. You might think that buying a case for your iPhone is negligible and doesn't really impact a country's economy. However, when everyone keeps purchasing products from abroad, this will impact a country's economy and trade balance.

Read on to find out what happens when everyone begins buying Chinese products from Amazon and when a country runs into a trade deficit. This explanation has covered the trade balance in detail, so don't miss it!

Balance of Trade Definition

Balance of trade definition refers to the difference between the value of a country's exports and the value of that country's imports during a specific time period. The difference in value between exports and imports is expressed in the unit of currency of a particular country.

For example, the trade balance of the U.K. is expressed in British pounds (£), whereas the balance of trade of the U.S. is expressed in dollar terms ($).

Balance of trade is the difference in value between a country's exports and imports over a specified period.

A nation's trade balance is part of a larger macroeconomic measurement, the balance of payments.

Balance of payments is the total value of payments made into and out of the country over a given period.

We have a detailed explanation of the balance of payments. Feel free to check it out!

The most important aspect of a nation's overall balance of payments is its balance of trade, whether a country has a trade deficit or a trade surplus.

Alternate names for the balance of trade include the trade balance, the international trade balance, the commercial balance, and net exports. All of these names refer to the same thing.

A nation is said to have a trade deficit or a negative trade balance if the value of the products and services it buys is greater than the value of what it exports.

A nation is said to have a trade surplus or a positive trade balance when it exports more products and services than it brings into the country.

If a country has a positive trade balance, its producers are selling their wares successfully on international markets. After enough items have been produced to fulfill the local market's needs, there is sufficient demand from buyers in other countries to keep local manufacturers busy.

A negative trade balance indicates that the cash flows out of the nation to pay for exports; this may suggest that the country is dependent on imported products.

The primary method for determining the balance of trade may be summed up as the difference between the entire value of a country's exports and the total value of its imports.

Balance of Trade vs. Current account

Although the balance of trade and current account are often used interchangeably, there are some differences between the balance of trade vs. the current account. The main difference between the balance of trade vs. the current account is that the balance of trade measures the difference in the value of exports and imports between countries. On the other hand, the current account measures the difference between total export and imports, foreign aid, and international investments.

The current account is an account that tracks a nation's international transactions for a set time. It includes net commerce in goods and services, net cross-border investment income, and net transfer payments.

Balance of trade is one of the biggest components of the current account. However, the current account is a broader measurement of international trade transactions between countries.

The current account balance of a country may either be in the form of a deficit or a surplus, depending on whether or not the nation's total revenues it receives from other countries are lower or higher than the total payments it has made to other nations.

When a nation sends more money overseas than it gets from other countries, this results in a current account deficit for the country.

A country is said to have a current account surplus when it brings in more money from other countries than it pays out.

We have an entire explanation on the Current Account. Check it out!

Because the trade balance (the difference between exports and imports) is often the single most crucial factor in determining whether or not there is a surplus or deficit on the current account, the current account balance frequently has a cyclical tendency.

Import quantities often soar during robust economic progress, but if exports cannot expand at a comparable pace, the current account imbalance will worsen as a result. On the other hand, the current account deficit will decrease during a recession if imports go down while at the same time exports go up to countries that are doing well.

Balance of Trade Deficit

Balance of trade deficits are present in many countries, and they significantly impact economies.

A trade deficit is present when a nation's imports within a specified period surpass its exports.

Trade deficits occur when a country cannot effectively generate its own goods because it lacks the knowledge and resources necessary to develop such goods and services or because it prefers to acquire commodities from another nation.

The effects of trade deficits include increased consumption and increased debt.

  • Increased consumption. When a country has a balance of trade deficit, it indicates that it imports a greater quantity of products and services from other countries than it sends to other countries. In such a case, this country is capable of consuming beyond its production possibilities, which is the total amount a country can produce, given it uses all of its resources. That means that a country that experiences a trade deficit balance contributes to an overall improvement in the household level of life.
  • Increased debt. It is undesirable to have a trade deficit since it requires additional financing, which might come in the form of borrowing money from the rest of the world, selling off assets, or delving into government reserves. If a country is running into a trade deficit, it has more money flowing out of the country to pay for the imports; however, to make up for that, that country has to incur debt. One example would be selling financial assets and using those funds to pay for imports.

Balance of Trade Deficit: United States Example

The United States is one of the most common examples of the balance of trade deficits.

Balane of Trade U.S trade deficits StudySmarterFig. 1 - U.S. Trade Deficits. Source: FRED St. Louis.1

Figure 1 shows the U.S. balance of trade deficits between 2000-2021. The U.S. has been experiencing a deterioration in the balance of trade from the year 2000 up to 2006. The peak of the deficit improvement occurred shortly before 2010. After being relatively stable between 2011 and 2015, the trade deficit declined again in 2020 due to the effects of the pandemic.

The income growth experienced in the U.S. allowed its citizens to increase the purchases of goods and services from abroad, which is one of the main contributors to this enormous trade deficit. Another reason is the trade between U.S. and China. Due to China's ability to use cheap labor, making its products cheaper, the U.S. has been increasingly purchasing Chinese goods and services.

Balance of Trade and Exchange Rate

The balance of trade and the exchange rate are strongly influenced by one another. The balance of trade has an impact on the rates of currency exchange because of the way it affects the supply and demand for foreign currency.

When a nation's balance of trade does not balance out to zero — that is, when exports do not equal imports — there is significantly greater supply or demand for the country's currency, depending on the situation. On the global market, the price of that currency is affected as a result of this.

The values offered for currency exchange are relative to one another; the price of one currency is defined in terms of another currency.

For example, one dollar in U.S. currency may be equivalent to 0.86 British pounds. To put it another way, if an American company or individual wanted to exchange dollars for British pounds, they purchased 0.86 British pounds for every dollar they sold, and a British company would buy 1 dollar for every 0.86 British pounds they sold.

The demand for currency, which is impacted by trade, is a significant factor affecting these relative values.

When a nation generates more revenue through exports than imports, there is a strong demand for the nation's products and, therefore, for the nation's currency. When there is a high level of need for a good or service, prices tend to go up, and the value of a currency tends to go up as well.

On the other hand, if a nation's imports exceed its exports, then there is a significantly lower demand for that nation's currency, and as a result, prices should fall.

We have covered the Foreign exchange market in detail. Feel free to check it out!

Effects of Depreciation on the Trade Balance

A country's currency can either appreciate or depreciate, which will have effects on the trade balance.

Depreciation of a currency is the loss in value of a country's currency in terms of another currency.

For illustration purposes, let us assume that the sole commodity available on the market is candy bars and that the U.K. imports more candy bars from the United States than it exports. As it imports, which means that it buys more from the United States than it sells to it, it means that it needs more dollars than the pound (to pay for the candy bars). As a result, the demand for U.S. dollars in the U.K. is higher than the demand for the pound in the United States because the United States is selling more candy bars to the U.K.

When the demand for the U.S. dollar is higher than the demand for the pound, it results in a relative depreciation of the pound. When a nation's currency loses value, the goods that the country exports become relatively more appealing to buyers in other countries.

Let's say a candy bar in the United States costs $1. Before the depreciation of their currency, a British guy could purchase an American candy bar for the equivalent of 0.86 pounds. After the depreciation of the British pound in terms of the dollar, a British guy would have to buy the exact same candy bar for 1 pound. This is assuming that there was a depreciation of the British pound from 0.86 pounds per dollar to 1 pound per dollar.

On the other side, a candy bar in the U.K. that used to cost 0.7 pounds has become much more affordable for U.S. citizens for the same amount of money. A U.S. buyer can now get more candy bars in the U.K. than before (due to depreciation).

People in the United Kingdom will buy fewer candy bars in the United States, that's because the pound has experienced a depreciation, which has made U.S. candy bars more expensive. People in the United States will start buying more candy bars from the U.K. as they become less expensive (due to the depreciation of the pound).

This then starts to affect the overall balance of trade. When a country experiences a currency depreciation, it exports more and it imports relatively less. The result would be that the trade balance experiences an improvement. The improvement can either come from an increase in the surplus or an decrease in the deficit.


Balance of Trade - Key takeaways

  • Balance of trade is the difference in value between a country's exports and imports over a specified period.
  • A nation is said to have a trade deficit or a negative trade balance if the value of the products and services it buys is greater than the value of what it exports.
  • A nation is said to have a trade surplus or a positive trade balance when it exports more products and services than it brings into the country.
  • The effects of trade deficits include increased consumption and increased debt.

References

  1. Fig. 1 - U.S. Trade Deficits. Source: FRED St. Louis Economic Data, Trade Balance: Goods and Services, Balance of Payments Basis, https://fred.stlouisfed.org/series/BOPGSTB#0

Frequently Asked Questions about Balance of Trade

Balance of trade is the difference in value between a country's exports and imports over a specified period.

Yes. A nation's trade balance is part of a larger macroeconomic measurement - the balance of payments.

Yes, the balance of trade is a part of the current account.

You take the difference between the total value of exports and the total value of imports.

A nation is said to have a trade deficit or a negative trade balance if the value of the products and services it buys is greater than the value of what it exports. 

A nation is said to have a trade surplus or a positive trade balance when it exports more products and services than it brings into the country.

Final Balance of Trade Quiz

Question

What is balance of trade?

Show answer

Answer

Balance of trade is the difference in value between a country's exports and imports over a specified period.

Show question

Question

A nation's trade balance is NOT part of a larger macroeconomic measurement, the Balance of payments. 

Show answer

Answer

False

Show question

Question

What is balance of payments?

Show answer

Answer

Balance of payments refers to the total value of payments made into and out of the country over a given period.

Show question

Question

___________ refers to the total value of payments made into and out of the country over a given period.

Show answer

Answer

Balance of payments

Show question

Question

A nation is said to have a ________ if the value of the products and services it buys is greater than the value of what it exports. 

Show answer

Answer

Trade deficit 

Show question

Question

A nation is said to have a ________ when it exports more products and services than it brings into the country.

Show answer

Answer

Trade surplus 

Show question

Question

What's the main difference between balance of trade and current account?

Show answer

Answer

The terms balance of trade and current account may be used interchangeably by many. However, there are some differences between the two terms. The main difference between the balance of trade vs. the current account is that the balance of trade measures the difference in the value of exports and imports between countries. On the other hand, the current account measures the difference between total export and imports, foreign aid, and international investment.

Show question

Question

What is the current account?

Show answer

Answer

The current account tracks a nation's international transactions for a set time. It includes net commerce in goods and services, net cross-border investment profits, and net transfer payments.

Show question

Question

When a nation sends more money overseas than it gets from other countries, this results in a __________ for the country. 

Show answer

Answer

Current account deficit

Show question

Question

Because the trade balance (the difference between exports and imports) is often the single most crucial factor in determining whether or not there is a surplus or deficit in the current account, the current account balance frequently has a ___________ tendency. 

Show answer

Answer

Cyclical

Show question

Question

The current account deficit will decrease during a recession if imports go down while at the same time exports go up to countries that are doing well.


Show answer

Answer

True 

Show question

Question

What are the effects of trade deficit?

Show answer

Answer

The effects of trade deficits include increased consumption and increased debt.

Show question

Question

Explain how trade deficit leads to increased consumption.

Show answer

Answer

When a country has a balance of trade deficit, it indicates that it imports a greater quantity of products and services from other countries than it sends to other countries. In such a case, this country is capable of consuming beyond its production possibilities, which is the total amount a country can produce, given it uses all of its resources. That means that a country that experiences a trade deficit balance contributes to an overall improvement in the household level of life. 

Show question

Question

What is the depreciation of a currency?

Show answer

Answer

Depreciation of a currency occurs when a currency loses its value in terms of another currency.

Show question

Question

What are the effects of the depreciation of a currency on the trade balance?

Show answer

Answer

When a country experiences a currency depreciation, it exports more than it imports. The result would be that the trade balance experiences an increase, as exports would be higher than imports.

Show question

Question

Why the balance of trade impacts the currency exchange rate?

Show answer

Answer

The balance of trade has an impact on the rates of currency exchange because of the way it affects the supply and demand for foreign currency. 

Show question

Question

What do we mean when we say that inflation is high?

Show answer

Answer

The general price level increases.

Show question

Question

The rate at which one currency trades against another currency is called?

Show answer

Answer

The nominal exchange rate.

Show question

Question

The exchange rate that is adjusted for the aggregate price levels in different economies is called ______.

Show answer

Answer

The real exchange rate.

Show question

Question

The formula for the real exchange rate is?

Show answer

Answer

\(\hbox {Real exchange rate} = \hbox {Nominal exchange rate} \times \frac {\hbox {Domestic price index}} {\hbox{Foreign price index}} \)



Show question

Question

We want to know whether the same burger costs more in one country than in another. Which of the following can tell us that?

Show answer

Answer

The general price levels.

Show question

Question

What do we need to calculate the real exchange rate of two currencies?

Show answer

Answer

The price indexes of the two countries.

Show question

Question

True / False: The real exchange rate and purchasing power parity are the same concepts.

Show answer

Answer

False.

Show question

Question

Does inflation have a direct impact on the nominal exchange rate?

Show answer

Answer

No.

Show question

Question

All else equal, what happens when Mexico's central bank increases the money supply?

Show answer

Answer

The Mexican peso depreciates in value against other currencies.

Show question

Question

All else equal, what happens when the Federal Reserve increases the interest rate?

Show answer

Answer

The US dollar appreciates in value against other currencies.

Show question

Question

What would make the real exchange rate unchanged if the Canadian dollar depreciates 20% against the US dollar?

Show answer

Answer

The general price level in Canada rises by 20%.

Show question

Question

The US has an inflation rate of 8%. What happens to the real exchange rate?

Show answer

Answer

The US dollar appreciates.

Show question

Question

Turkey experiences an inflation rate of 20%. All else equal, what happens to the real exchange rate?

Show answer

Answer

Things in Turkey become more expensive for foreigners.

Show question

Question

If the general price levels stay the same and the Turkish lira depreciates against other currencies (nominal exchange rate), what happens to the real exchange rate?

Show answer

Answer

Things in Turkey become less expensive for foreigners.

Show question

Question

Turkey experiences an inflation rate of 20%, and the Turkish lira loses 80% of its value in nominal terms. What happens to the real exchange rate?

Show answer

Answer

Things in Turkey cost less for foreigners.

Show question

Question

Define capital flight.

Show answer

Answer

Capital flight is when the domestic economy experiences a sudden and dramatic loss of demand for large amounts of assets.

Show question

Question

True/False: Capital flight can only happen in poorer, developing nations.

Show answer

Answer

False. Capital flight can happen to any nation, even wealthy, developed nations.

Show question

Question

What is net capital outflow?

Show answer

Answer

Net capital outflow is foreign assets bought by domestic consumers minus the domestic assets bought by foreign consumers.

Show question

Question

Who does capital flight benefit?

Show answer

Answer

The domestic country whose assets are leaving.

Show question

Question

Why are poorer, less developed nations more at risk of experiencing capital flight?

Show answer

Answer

They are more likely to experience capital flight because they are more likely to experience political unrest and tend to have weaker, more volatile currencies that are more prone to high inflation.

Show question

Question

What is not a cause of capital flight?

Show answer

Answer

Low inflation.

Show question

Question

Why does a nation's political stability matter to asset holders?

Show answer

Answer

A nation's political instability can cause uncertainty in economic policy and future financial decisions which could negatively impact the value of assets.

Show question

Question

When a currency is experiencing high inflation, what happens to the investor's purchasing power and why does it cause capital flight?

Show answer

Answer

The investor's purchasing power is lower, which pushes them to buy foreign assets where the currency affords them a higher purchasing power.

Show question

Question

What does capital flight do to economic growth?

Show answer

Answer

It restricts economic growth because it reduced domestic investment into the country.

Show question

Question

Capital flight causes _____ to increase while _____ decreases.

Show answer

Answer

Interest rates, the exchange rate.

Show question

Question

What does capital flight mean for domestic businesses looking to take out a loan?

Show answer

Answer

It will reduce domestic businesses' desire to borrow funds since capital flight increases the interest rate which makes borrowing more expensive. 

Show question

Question

What is not a disadvantage of capital flight?

Show answer

Answer

Low interest rates.

Show question

Question

How does an increased supply of domestic currency affect the purchasing power of the domestic currency?

Show answer

Answer

It lowers the purchasing power because the value of the currency decreases.

Show question

60%

of the users don't pass the Balance of Trade quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.