Answer to Question #100061 in Macroeconomics for Tiffany

Question

2. The U.S. economy experienced large trade deficits in the 1980s and 1990s and tremendous economic growth in the mid- and late-1990s.

a. Trade deficits have an effect on inflation. Explain the relationship between trade deficits and investment verbally and mathematically using the concept of the balance of payments.

b. Explain verbally the relationship between investment and long-term economic growth and describe the relationship graphically in an AD/AS graph.

Answer 1

a. Trade deficit provides opportunities for domestic businesses to produce quality goods and services to match foreign products. With domestic products available at lower prices, the inflation rate decreases. And a market with a wide variety of both domestic and imported goods provides the element of choice to the consumers. In such a case, an increase in imports indicates a fast, growing economy. And a growing economy attracts more foreign investment.

b. Increase in investment can increase not only aggregate demand, but also aggregate supply in the long-run, so it can cause the long-term economic growth.