Assume a u. s. firm buys (imports) $5 million (in u. s. dollars) of foreign goods. that transaction by itself increases the trade deficit by $5 million. but, the $5 million will flow back to the united states to purchase either (i) u. s. goods and services or (ii) u. s. assets. • how does the way the $5 million comes back to the united states determine whether there will be balanced trade or a trade deficit? • how does the u. s. economy benefit from either transaction (the foreign purchase of u. s. goods and services [exports] or the purchase of u. s. assets)?

Introduction:

When a country is importing more than it is exporting a trade deficit occurs. A trade deficit represents an outflow of domestic currency to foreign markets.

Every transaction a country makes with the world is summarized in the balance of payments. The balance of payments has two sub accounts:

The current account: Composed of goods and services

The capital and financial account: Composed of real and financial assets.

Answer 1.

a) The $5 million are used to purchase U.S goods and services.

In this case it is recorded on the current account as a positive number,this transaction compensates the $5 million that were recorded as a negative number and results in balanced trade.

b) The $5 million are used to purchase U.S assets

This is recorded on the capital and financial account  as a surplus but even though this compensates the deficit on the current account, there is still a trade deficit.

Answer 2.

If the $5 million used to purchase foreign goods return as goods and services, it will benefit the nation by creating more jobs and generating more income for American producers.

If the $5 million return as U.S. assets (International investment) they will allow firms to expand and will help to finance the national debt.

question 1: paragraph 3

question 2: paragraph 2

question 3: paragraph 1

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