Trade Deficit

What is a Trade Deficit?

Where the total sum of goods or services a country imports from the other countries of the world is higher than that of the sum of goods or services a country exports to the other countries, then such a situation is known as trade deficit which is the opposite of balance of trade theory.

Trade Deficit Formula

Trade Deficit = Value of Imports – Value Of Exports

Cause & Effect of Trade Deficit?

Cause: A trade deficit occurs when a country is not producing everything it needs a borrows from other countries to meet the nation’s needs. It also arises when companies manufacture in other countries.

Effects:  It raises the country’s standard of living, residents get wider access to a variety of goods and services at competitive prices. And, it also helps to minimize the threat of inflation since it creates at a lower price.

Examples

We will try to understand this term with the help of the example:

Trade Deficit

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For eg:
Source: Trade Deficit (wallstreetmojo.com)

Example #1

If the value of the imported items to the United States, was $2 trillion in the previous year, but the value of the exported items from the United States was $1.75 trillion, then the final outcome of the trade deficit of the United States would be a negative of $250 billion BOPBOPThe BOP (Balance of Payment) is a calculation of all payments and receipts of several products and services between one country and the rest of the world during a certain time period.read more.

Example #2

If we take historical data, the US had a trade deficit since 1976, while, China had a trade surplus in 1995.

US Trade Deficit

Trade Deficit - US

source: tradingeconomics.com

China Trade Surplus

Trade Surplus - China 1

Source: tradingeconomics.com

For the study of a country’s balance of tradeBalance Of TradeThe balance of trade (BOT) is the country’s exports minus its imports. BOT is one of the significant components for any current economic asset as it measures a country’s net income earned on global investments.read more, a trade surplus or trade deficit is not always sufficient, we need a final indicator of an economy’s health which can be considered during the study of the business cycleBusiness CycleThe business cycle represents the expansion and contraction of the economy that occurs due to ups and downs in the gross domestic product (GDP) of a country. It is experienced over the long term and goes parallel with the natural growth rate.read more and other economic indicators.

Advantages

Disadvantages

Key Point Due to Trade Deficit

  • As the economic theory suggests that consistent trade deficits give adverse effects on the nation’s economic outlook which directly impacts employment, growth, and devaluing its currency.
  • The United States, which is known as the world’s largest deficit nation. has proven these theories wrong. Due to its special status in the world and the dollar as the world reserve currency.
  • Smaller countries are highly impacted due to its negative effects that trade deficit brings a certain period of time. While proponent alleges that any negative effect of deficit recovers with respect to change in time.
  • Large trade deficit largely affects consumer preferences which are mitigated in the long run.

Conclusion

A trade deficit is not always detrimental, because it has a capability to re-correct itself over time. Import more from other countries decreases the prices of the consumer goods-producing inside the nation boundary which helps to control the inflation in the local economy. While an increase in imports also provides an abundance of opportunities to interact with diversity available to a nation’s residents. A fast-growing economy might import more, due to continuous expansion which creates an increase in demand. Consequently, a trade deficit shows the economy is growing continuously.

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