The trade balance is one of the main components of the gross domestic product (GDP) formula. GDP increases when there is a trade surplus, that is, the total value of goods and services that domestic producers sell abroad more than the total value of foreign goods and services that domestic consumers buy. If domestic consumers spend more on foreign goods than domestic firms sell to foreign consumers – the trade deficit – the GDP decreases.
The standard formula for GDP can be written as:
GDP = private consumption expenditure + investment + government spending + (exports – imports)
Understanding the trade balance
Very few economic entities have caused great confusion and controversy, as the trade balance. This confusion is due to the language involved in reporting the volume of trade in finished products; “trade deficit” sounds bad, but “balance of trade” sounds good.
While exchange rates are freely floating, however, trade imbalances never exist in the long term. Even if they did, there is little reason to believe that they will have negative consequences.
Suppose the United States held a trade deficit of 100 million U.S. dollars with Germany, largely because the Americans liked the German cars more than the Germans loved American cars. Payments in us dollars made by the Americans and German automakers to eventually return home in the form of dollar assets. Buying a German car, Americans sold $ on the Germans. In return, the Germans can buy assets such as Treasury bills (t-bills) or U.S. real estate. Therefore, even if US GDP will fall by $ 100 million that the U.S. economy is no worse (and actually used) the net exchange.
In addition, there are some problems with GD in General. Measures GDP in terms of dollars finished products and services in the economy; it is presented in terms of what consumers spent. It does not measure how efficiently the economy is producing the goods, whether the standard of living grow, or if the productive capital investments were done enough.