Wednesday, October 08, 2008

Explaining Why Trade Deficits Are Okay: Analogy # 1,295,674

Paraphrased discussion after today's class with student, thought it might be worth sharing:
Student: Recalling macro, imports were negative for GDP. In the news, they always mention how economic growth has increased to some extent because imports have been down lately.

Me: No, that is just a common misinterpretation of an accounting relationship. Think about a firm who keeps a income statement. On that income statement there are expenses like "employee salaries and benefits." These are subtracted from revenues to calculate profits, right?

Student: Right.

Me: Would the firm be more profitable if it didn't have employees and therefore didn't have to be paying salaries and benefits?

Student: <Initially looks like he wants to say yes, but then dawns on him> Okay, so firms hire the workers because they increase profits even after you take into account their costs.

Me: <Internally I am doing a happy dance> Very good. Trade is the same way for GDP, as it uses the balance of trade to measure our production, but it does not tell us that we would be better off if we imported less anymore than salary expenses tell firms they would be better off without those employees.


Thomas said...

You mean income statement, not balance sheet.

Justin M Ross said...

thanks, fixed it