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Net trade (X - M)

a) Influences on the (net) trade balance

Net trade is the total value of exports minus the total value of imports over a period of time and at a given price level (KEY DEFINITION). If a country has more exports than imports, they are in a trade surplus, and AD rises. If a country has fewer exports than imports, they are in a trade deficit, and AD falls. If a country has equal values of exports and imports, the trade balance is 0 and there is a neutral effect on AD.

The main influences on the (net) trade balance are as follows:

State of world economy - If the UK's main trading partner is currently in an economic boom, demand of its population will rise as their incomes rise. This increases demand for UK exports, leading to an improvement in net trade in the UK.

Protectionism - This is the practice of limiting trade and focusing on domestic production rather than importing lots of goods and services. If there is protectionism on UK exports in other countries, UK exports will fall due to lower demand. If there is protectionism in the UK on imports, due to regulations imports will fall. Protectionism can encourage retaliation, leading to trade wars such as the one between China and the US in 2018. In stark contrast, free trade is far more mutually beneficial as every country gains the benefit of gaining goods and services which are demanded by their populations, and net trade will become a more significant part of AD. Pre-BREXIT, 40% of trade in the UK was done with the EU (a free trade bloc). 

Exchange rates - This is a really weird concept to understand at first, so I will try to put it into very simple terms by using two mnemonic devices. The first is SPICEE, meaning Strong Pound Imports Cheap Exports Expensive. This means that if the pound gets stronger (appreciates in value), then the value of UK exports will rise. Because UK exports have a higher price than other comparative exports, they become less internationally competitive, and so UK exports fall. Also, because the pound is more valuable, it can buy more goods and services from abroad ceteris paribus. This makes imports cheaper, as we can now buy more for the same price in pound sterlings, increasing the demand for imports, so UK imports rise. As a result, net trade falls. These concepts can be applied to the second mnemonic device, WIDEC, meaning Weak pound Imports Dear Exports Cheap. In 2022, the pound depreciated significantly to an exchange rate of £1:$1.10, leading to a rise in net trade. In 2015, China devalued their currency purposefully to make their goods and services more internationally competitive, increasing net trade.

Real income - If real incomes in the UK rise, then imports will rise, as demand will increase due to higher disposable incomes, and the UK may not be able to meet this demand with domestic supply of goods and services alone. This decreases net trade. Although, if real incomes have risen due to export-led economic growth, then net trade will increase.

Non-price factors - If UK goods are of higher quality than foreign substitutes, then exports will rise as more people will demand goods of better quality. Also, imports will fall as UK consumers will be satisfied with the higher quality goods that are produced domestically resulting in an improvement in net trade. Also, if marketing campaigns are strong, this can impact on net trade, as better marketing may result in more demand for certain goods and services.

Use the word SPERN as a mnemonic device for remembering the factors which influence net trade!

To help revise this, click the button for my condensed flashcards!

EXAM TIP: Understanding these influences, particularly exchange rates, is key to getting the top grades!

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