Introducing Concepts - Trade Deficit and Surplus - Online Tutor, Practice Problems & Exam Prep

In an open economy, trade involves exporting goods and services to other countries and importing them as well. A trade surplus occurs when exports exceed imports, while a trade deficit arises when imports surpass exports. The balance of trade is influenced by factors like savings and investment, where savings indicate lower current consumption compared to output. Economic investment focuses on enhancing future production through resources like factories and technology. Understanding these concepts is crucial for analyzing economic health and international trade dynamics.

Trade Deficit and Trade Surplus

Alright. Now let's introduce the concepts of trade deficits and trade surplus. So when we talk about trading with other countries, we talk about economies that are open economies. An open economy trades. It trades with other countries. It trades its goods and services for goods and services produced abroad. Okay? Compare that to a closed economy. A closed economy is a country that does not trade. They do not trade with other countries. They are closed economy. Well, generally, we talk about open economies, right? We're generally trading with other countries. So when we do trade with other countries, we're going to be exporting goods and importing goods and services. When we export, that's us selling things to other countries. So goods and services sold in other countries, those are exports, right? You should probably be familiar with this term at least that when we export goods, we sell them in other countries where imports, that's the opposite. Goods and services bought from other countries, so they're produced in the other country and they're purchased and sold here in our country, right? Here in the US, something like that.

So what do we talk about? A trade surplus or a trade deficit? Well, it comes down to the exports and imports. The level of exports and the level of imports. When do you think we have a trade surplus? Is it when the exports are higher or the imports are higher? It's when the exports are higher, right? We're selling more to other countries than we're buying in from other countries. We have a surplus of our trade. We're selling more than we're purchasing. That's a surplus there. Compare that to a closed economy, right? So exports are less than the imports when we have a trade deficit.

So if we look here on this graph, we've got a few different countries, that we're going to label here. The first one here is the USA. So the USA, notice the level of imports and exports. We've got our legend up here. We are running a trade surplus or deficit. What do you see? The imports are greater, right? We purchase a lot from other countries, namely China, and that causes us to run a trade deficit. So let's look at some other countries here. This next one is Germany and what do they have? Are they running a trade surplus or deficit? They have a surplus. Right? They're exporting more than they're importing. Next is China. I noticed the level, the level of their exports is that it almost matches our level of imports here in the USA. Doesn't mean that all the exports of China are going to the USA. They export all around the world, but they are also running a trade surplus, right? Their exports are greater than their imports and finally, we have Saudi Arabia here. Notice how their trade is a lot smaller, but they've got a big gap there between their exports and imports. And obviously most of their exports come from gasoline, petrol. So there we go. We've got a few different countries there.

Now obviously, the USA is not the only country in the world running a trade deficit, but we have been consistently running a trade deficit for a while now. Now, when you see trade deficit, you think, oh no, trade deficit. It sounds like such a bad thing. Is a trade deficit bad? Is a trade surplus good? The answer is really, it depends. It doesn't really mean one thing or another. Well, we have to think about when it comes to international trade, why is there international trade? We've discussed this in other videos. It comes up in microeconomics. It comes up here in macroeconomics as well. Well, international trade is a result of comparative advantage. Comparative advantage. See if I can squeeze it all in here. There we go. Comparative advantage and remember, comparative advantage means that you produce what you're good at producing, right? What you have a lower opportunity cost of producing, that's what you produce and you trade with the rest of the world.

So that is the real measure of why we export and import. The trade deficits and trade surpluses, they change over time. However, the determinant of the balance of why there's an increase in exports or a decrease in imports or the balance between the two, it comes from saving and investment. So current consumption, when we talk about savings, that means current consumption is less than current output. So if we're saving, that means that our current consumption is less than the output. So if you think about the US economy, well, we're consuming more when it comes to this trade deficit, right? We're importing a lot. We're consuming things from other companies, from other countries more than what we're producing and exporting or producing ourselves, right? So we could think that we're generally in a situation we're not saving as much here, right? We are consuming more in the current, based on these trade levels. Compare that with investment. So investment, this is a little different than savings. The idea of investment is where we're taking current resources what we have now and we're devoting them to increasing future output. Okay?

So we might have talked about this before, but some of you are seeing this for this first time. So investment, this is where we're taking current resources and devoting them to increasing future output. What does that mean? So it means similar to savings where we're reducing current consumption, however, we're taking that, reduction of consumption and we're investing it into the future to increase the future. The future consumption. The future output leading to future consumption. Well, when we talk about investment generally in your head, you're generally going to think of financial investments, which are generally what you think of when you hear investment. You think of things like stocks and bonds, mutual funds, those type of things. Those are financial investments. However, when we talk about investments in this class, we're generally talking about economic investment. And economic investment, that's things like factories, machinery, right? Things that are increasing our future output. Things we purchase today like we build a factory today, well, that's not going to increase output today. That's going to increase output in the future when we're using the factory or even research and development or we're developing new technologies that are going to increase our future production, make us more productive later.

Alright? So for now, we're going to leave it at this high level, but what you want to know is that a trade deficit or trade surplus does not necessarily mean oh, a trade surplus that's this economy is really strong or a trade deficit, this economy is really struggling. It's not exactly later videos, but this is just kind of an introduction of the topic of savings, investments, trade deficits, and surplus that whole idea. Cool? So let's take a pause here and let's move on to the next video.

Here’s what students ask on this topic:

What is the difference between a trade deficit and a trade surplus?

A trade deficit occurs when a country's imports exceed its exports, meaning it buys more goods and services from other countries than it sells to them. Conversely, a trade surplus happens when a country's exports exceed its imports, indicating it sells more to other countries than it buys. These concepts are crucial for understanding the balance of trade, which reflects a country's economic interactions with the rest of the world. While a trade deficit might suggest higher current consumption, a trade surplus could indicate stronger production capabilities.

How does a trade deficit impact the economy?

A trade deficit can have various impacts on an economy. It may indicate that a country is consuming more than it produces, relying on foreign goods and services. This can lead to increased foreign debt if financed through borrowing. However, it can also mean that the country is attracting foreign investment, which can be beneficial for economic growth. The overall impact depends on factors like the reasons behind the deficit, the country's economic policies, and its ability to manage foreign debt.

What factors influence a country's trade balance?

Several factors influence a country's trade balance, including comparative advantage, exchange rates, economic growth, and government policies. Comparative advantage allows countries to specialize in producing goods at a lower opportunity cost, promoting trade. Exchange rates affect the cost of exports and imports. Economic growth can increase demand for imports. Government policies, such as tariffs and trade agreements, also play a significant role in shaping the trade balance.

Is a trade surplus always beneficial for an economy?

A trade surplus is not always beneficial. While it indicates that a country exports more than it imports, suggesting strong production capabilities, it can also lead to economic imbalances. For instance, excessive reliance on exports can make an economy vulnerable to global market fluctuations. Additionally, a trade surplus might result from low domestic consumption, which could indicate underlying economic issues. Therefore, the benefits of a trade surplus depend on the broader economic context.

How do savings and investment affect the trade balance?

Savings and investment play crucial roles in determining the trade balance. Higher savings mean lower current consumption, which can reduce imports and improve the trade balance. Investment, particularly economic investment in factories and technology, enhances future production capabilities, potentially increasing exports. The balance between savings and investment influences whether a country runs a trade deficit or surplus, reflecting its economic priorities and future growth prospects.