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 are only one element of an economy's balance of payments, they are considered to be most significant element.
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.