SOLUTIONS TO SELF-CHECK QUESTIONS

14.1 Measuring Trade Balances

1. The stock and bond values will not show up in the current account. However, the dividends from the stocks and the interest from the bonds show up as an import to income.
2. It becomes more negative as imports, which are a negative to the current account, are growing faster than exports, which are a positive.
   1. Money flows out of the Mexican economy.
   2. Money flows into the Mexican economy.
   3. Money flows out of the Mexican economy.

14.2 Trade Balances in Historical and International Context

1. GDP is a dollar value of all production of goods and services. Exports are produced domestically but shipped abroad. The percent ratio of exports to GDP gives us an idea of how important exports are to the national economy out of all goods and services produced. For example, exports represent only 14% of U.S. GDP, but 50% of Germany’s GDP
2. Divide $542 billion by $1,800 billion.
3. Divide –$400 billion by $16,800 billion.
4. The trade balance is the difference between exports and imports. The current account balance includes this number (whether it is a trade balance or a trade surplus), but also includes international flows of money from global investments.

14.3 Trade Balances and Flows of Financial Capital

1. a. An export sale to Germany involves a financial flow from Germany to the U.S. economy.

b. The issue here is not U.S. investments in Brazil, but the return paid on those investments, which involves a financial flow from the Brazilian economy to the U.S. economy.

c. Foreign aid from the United States to Egypt is a financial flow from the United States to Egypt.

d. Importing oil from the Russian Federation means a flow of financial payments from the U.S. economy to the Russian Federation.

e. Japanese investors buying U.S. real estate is a financial flow from Japan to the U.S. economy.

2. The top portion tracks the flow of exports and imports and the payments for those. The bottom portion is looking at international financial investments and the outflow and inflow of monies from those investments. These investments can include investments in stocks and bonds or real estate abroad, as well as international borrowing and lending.

3. If more monies are flowing out of the country (for example, to pay for imports) it will make the current account more negative or less positive, and if more monies are flowing into the country, it will make the current account less negative or more positive.

14.4 The National Saving and Investment Identity

1. a. domestic savings decreases; the trade deficit will rise.

b. Government runs a deficit and needs to borrow; the trade deficit must rise bring in funds from abroad.

c. domestic investment rises; trade deficit must rise to provide extra capital.

2. The government is saving rather than borrowing. The supply of savings, whether private or public, is on the left side of the identity.

3. A trade deficit is determined by a country’s level of private and public savings and the amount of domestic investment.

4. The trade deficit must increase. To put it another way, this increase in investment must be financed by an inflow of financial capital from abroad.

5. Incomes fall during a recession, and consumers buy fewer good, including imports.

6. A booming economy will increase the demand for goods in general, so import sales will increase. If our trading partners’ economies are doing well, they will buy more of our products and so U.S. exports will increase.

14.5 The Pros and Cons of Trade Deficits and Surpluses

1. Foreign investors worried about repayment so they began to pull money out of these countries. The money can be pulled out of stock and bond markets, real estate, and banks.

2. A rapidly growing trade surplus could result from a number of factors, so you would not want to be too quick to assume a specific cause. However, if the choice is between whether the economy is in recession or growing rapidly, the answer would have to be recession. In a recession, demand for all goods, including imports, has declined; however, demand for exports from other countries has not necessarily altered much, so the result is a larger trade surplus.

14.6 The Difference between Level of Trade and the Trade Balance

1. Germany has a higher level of trade than the United States. The United States has a large domestic economy so it has a large volume of internal trade.

2 a. A large economy tends to have lower levels of international trade, because it can do more of its trade internally, but this has little impact on its trade imbalance.

b. An imbalance between domestic physical investment and domestic saving (including government and private saving) will always lead to a trade imbalance, but has little to do with the level of trade.

c. Many large trading partners nearby geographically increases the level of trade, but has little impact one way or the other on a trade imbalance.

d. The answer here is not obvious. An especially large budget deficit means a large demand for financial capital which, according to the national saving and investment identity, makes it somewhat more likely that there will be a need for an inflow of foreign capital, which means a trade deficit.

e. A strong tradition of discouraging trade certainly reduces the level of trade. However, it does not necessarily say much about the balance of trade, since this is determined by both imports and exports, and by national levels of physical investment and savings.