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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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BuyFindarrow_forward

Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

Sketch a diagram of how a budget deficit causes a trade deficit. (Hint: Begin with what will happen to the exchange rate when foreigners demand more U.S. government debt.)

To determine

To discuss: The investment offsets in deficit demand used by government with the help of graphs.

Explanation

Trade deficits are defined as the imports are greater than exports. It is considered as the important measure for international trade where there exists an outflow of domestic currency to foreign markets.

In order to explain the link between budget deficit and trade deficit, it is needed to focus on the exchange rate. In the foreign exchange rate, the equilibrium will occur at the intersection of demand and supply of US Dollars. It is assumed that there is a budget deficit. The International investors have increased the demand for dollars in foreign market and the supply of dollars decrease.

Let us consider the case of exchange rate for US Dollars. Diagramatically, it can be explained as done below:

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