The achievement of an overall balance of payments with the rest of the world is a key macroeconomic policy objective for a national economy.
Although trade flows (including trade in goods and services) are only one element of an economy's balance of payments, trade flows of imports and exports are considered to be most significant element.
The balance of payments also includes other components of the current account, such as earnings from investments, as well as the capital account.
A trade deficit means that the total value of trade in goods and services exported is less than the value imported over a period of time.
Trade deficits can occur for several reasons, including:
As noted, one consequence of rapid economic growth is that consumption rises, including the consumption of imports. The cross diagram can help explain this.
Imports are a positive function of income [M = fY], with ‘f’ the marginal propensity to import (or MPM, for short). So, as income rises, imports rise with it.
The assumption is that exports are a function of overseas’ GDP, hence the export line has a zero gradient.
As GDP increases (from Y to Y1), imports rise (from a to b), opening up a deficit of b to c. The greater the MPM, (at M1) the larger the trade deficit (c to d) as a result of growth.