2.2.5 - Net trade (X-M)

Question 1

What are the main influences on the (net) trade balance.

Answer 1

o real income
o exchange rates
o state of the world economy
o degree of protectionism
o non-price factors

Question 2

Real income

Answer 2

An increase in real incomes will cause the demand for goods/services to increase (the extent to which depends on the marginal propensity to consume). However, as the majority of UK goods are imported, an increase in the demand for goods will increase the demand for imports. This will cause the expenditure on imports to increase, thus worsening the UK’s net trade balance. On the other hand, a decrease in real incomes will cause the expenditure on imports to decrease, improving the UK’s net trade.

Question 3

Exchange Rates

Answer 3

A strong exchange rate makes imports cheaper and exports more expensive relative to other countries. Therefore, the demand for imports will increase, whilst the demand for exports will decrease. This will cause the revenue gained from exports to decrease and the expenditure on imports to increase. Overall, this will result in a worsening of the UK’s net trade balance.

In contrast to this, a weak exchange rate will make imports more expensive and exports cheaper relative to other countries. As a result of this, demand for imports will fall and demand for exports will increase. This will increase the revenue gained from exports and decrease the expenditure on imports, thus improving the UK’s net trade balance.

SPICEC = -Strong pound Imports Cheaper Exports Dearer

WPIDEC = Weak pound imports dearer exports cheaper

Question 4

*State of the world economy**

Answer 4

An improvement in the economic performance of countries abroad often results in an increase in real incomes abroad. This increases the demand for goods/services, some of which are imported from the domestic country. Therefore, an increase in real incomes abroad can result in an increase in the demand for the domestic country’s exports (especially if the foreign countries are big importers of goods from the domestic country). This will result in an increase in the amount of revenue gained from exports, thus improving the net trade balance. Conversely, a decrease in real incomes abroad will cause a decrease in the revenue gained from exports and therefore a worsening of the net trade balance. An example of this can be found from 2012 to 2014 where slow economic growth in the Eurozone led to the UK’s export revenue being stagnant over that time period, which is in contrast to the growth in export revenue that was seen previously from 2010 to 2012.

Question 5

Degree of protectionism

Answer 5

Question 6

Non-price factors

Answer 6

The main non-price factor influencing the net trade balance is the quality of goods/services that the domestic country sells. If they are high then those who care about quality may buy from the domestic country despite their prices being higher relative to other countries. By selling quality goods/services demand is likely to be more price inelastic. This means that although the price of the domestic country’s goods/services are higher relative to other countries, they may still gain lots of revenue from exports and therefore have a positive net trade balance.

Innovation can also play a big part in determining a country’s net trade balance. A country that is very innovative is likely to develop goods/services that are not available in other countries. Therefore, although the price of the domestic good/service may be relatively high, there is still likely to be demand for it, as it is not available anywhere else. This will have a positive impact on the net trade balance of a country.