2.2.5 Net Trade — Practice Questions
Seven original multiple-choice questions on net trade, written to the style and difficulty of Edexcel Paper 2 Section A. One is a calculation.
Not read the notes yet? Start with the 2.2.5 Net Trade revision notes.
9 questions in this set
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1. A country's exports are £520bn and its imports are £555bn. Net trade's contribution to aggregate demand is
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Answer: A (−£35bn). Net trade is exports minus imports:
£520bn − £555bn = −£35bn.
The country buys more from abroad than it sells, so net trade subtracts £35bn from aggregate demand. The money spent on imports is demand for output produced somewhere else, which is why it comes off rather than going on.Why the other options are wrong
- B — The size is right but the sign is wrong. Imports exceed exports, so the contribution must be negative.
- C — £520bn is exports alone. Net trade is the difference between the two flows, not one of them.
- D — This adds the two figures. Imports are subtracted from exports, never added to them.
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2. Real incomes in a country rise strongly while incomes in its trading partners are unchanged. The most likely effect on net trade is that it
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Answer: C (Worsens, as households can afford more imports.). Higher domestic real incomes raise spending on everything, and a share of that spending goes on imported goods — cars, electronics, foreign holidays.
Imports therefore rise. Exports are unchanged, because incomes abroad have not moved and nothing has happened to competitiveness. With M up and X flat, net trade worsens.
This is why a domestic boom and a widening trade deficit so often arrive together.Why the other options are wrong
- A — Nothing here has changed relative prices. Domestic incomes rising does not make exports cheaper to foreign buyers.
- B — Some of the extra spending does go on domestic goods, but that does not affect net trade. What matters is the part that goes on imports.
- D — Export prices are set by costs and the exchange rate, neither of which the stem changes.
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3. A country's main trading partners enter a deep recession. For that country's net trade, the most likely effect is
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Answer: C (A worsening, as its exports fall.). This is the mirror of the previous case: it is foreign real incomes that have moved.
Households and firms abroad have less to spend, so they buy less of everything, including this country's exports. X falls while M is broadly unchanged, and net trade worsens.
For an open economy like the UK, where exports and imports are a large share of GDP, conditions abroad are usually the most important short-run influence on the trade balance — and they are entirely outside the country's control.Why the other options are wrong
- A — A recession abroad does not reduce this country's appetite for imports. Domestic incomes have not changed.
- B — Exports fall rather than rise. Poorer customers buy less.
- D — Imports depend on domestic incomes, which the stem leaves untouched.
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4. A country's currency depreciates. Its trade balance worsens for several months before it begins to improve. The best explanation is that in the short run
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Answer: D (Volumes respond only slowly to the price change.). A depreciation changes prices immediately but quantities only gradually. Contracts are already signed, supply chains take time to switch, and buyers need time to notice and react.
So in the first months the country pays more for much the same volume of imports while earning much the same volume of exports at lower prices — and the balance worsens. As demand becomes more responsive over the following year or two, volumes shift, and the balance improves.
The path traced out is a shallow dip followed by a sustained rise.Why the other options are wrong
- A — A depreciation makes exports cheaper to foreign buyers and imports dearer at home. The stem's puzzle is why the balance still worsens at first.
- B — Imported inputs do become dearer, which feeds into domestic prices. But that is a story about inflation, not about why the trade balance dips and then recovers.
- C — Nothing in the stem mentions retaliation, and a depreciation is not a protectionist measure that would invite it.
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5. A government imposes tariffs on imports in order to improve its trade balance. The main risk to that aim is that
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Answer: D (Trading partners retaliate against its exports.). Tariffs work on one side of the balance: they raise the price of imports, so fewer are bought. If nothing else happened, the balance would improve.
Something else usually does happen. Trading partners answer with tariffs of their own, and exports fall. Since net trade is X − M, a policy that cuts imports and exports together may leave the balance no better and possibly worse — while both countries end up with dearer goods and less efficient production.Why the other options are wrong
- A — Switching to domestic substitutes is the intended effect, not a risk. It is how the tariff reduces imports.
- B — Dearer imports are the mechanism of the policy and a genuine cost to consumers, but they do not threaten the trade-balance aim.
- C — Revenue is a benefit to the government. It has no bearing on whether the trade balance improves.
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6. Table 1 lists four changes affecting a country's trade.
Using Table 1, the change that works through non-price competitiveness isTable 1: Four changes affecting trade Change Change 1 The domestic currency appreciates Change 2 Domestic firms improve product quality and branding Change 3 Trading partners grow strongly Change 4 Foreign governments cut their tariffs Show model answer
Answer: B (Change 2.). Non-price competitiveness covers everything that makes buyers choose a product other than its price — quality, design, reliability, branding, after-sales service and innovation.
Improving quality and branding makes exports more attractive at an unchanged price. That is a durable advantage: unlike a cheaper currency it cannot be undone by a movement in the exchange rate, which is why it is the route governments favour for the long run. The other three all work through price.Why the other options are wrong
- A — An appreciation changes the price foreign buyers face, making exports dearer and imports cheaper.
- C — Stronger growth abroad works through foreign real incomes — customers have more to spend, at unchanged prices.
- D — Lower tariffs abroad reduce the price foreign buyers pay for this country's goods, so again a price effect.
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7. For the UK, the state of the world economy is usually the most important short-run influence on the trade balance. The reason is that the UK
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Answer: B (Has a large share of GDP in exports and imports.). The UK is a relatively open economy: trade accounts for a large share of GDP in both directions.
Openness is what turns conditions abroad into a domestic problem. When a large fraction of output is sold overseas, a downturn in customer countries hits export demand hard and fast — and no amount of domestic policy can conjure buyers who have stopped spending. A more closed economy would feel the same world downturn far less.
The other influences on net trade are real, but exchange rates, competitiveness and protectionism all work more slowly than a change in world demand.Why the other options are wrong
- A — The pound floats. A fixed rate would if anything insulate trade flows from currency movements, which is not the mechanism here.
- C — The UK is a relatively open trading economy with low tariffs. High tariffs would reduce its exposure to world conditions, not raise it.
- D — The UK runs a persistent deficit on trade in goods, partly offset by a surplus on services. In any case the direction of the balance is not what makes it sensitive to world demand.
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8. A government considers allowing its currency to depreciate in order to improve the trade balance. Its economists report that demand for both its exports and its imports is highly price inelastic. The advice they should give is that a depreciation
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Answer: C (Would probably worsen the balance, not improve it.). The Marshall-Lerner condition says a depreciation improves the trade balance only if the price elasticities of demand for exports and imports sum to more than one.
If both are highly inelastic that sum is below one, and the depreciation makes matters worse. The reason is that quantities barely move: the country still buys much the same volume of imports and now pays more for them, while still selling much the same volume of exports for less.
A weaker currency is therefore not a reliable cure for a trade deficit. Whether it works at all depends on how responsive buyers on both sides turn out to be.Why the other options are wrong
- A — Exports do become cheaper, but that only improves the balance if foreign buyers respond by buying enough more. Inelastic demand means they do not.
- B — The balance certainly changes — import bills rise immediately. It is the direction of the change that the elasticities decide.
- D — A currency that is fixed cannot depreciate in the market at all. Devaluation under a fixed rate faces exactly the same elasticity test.
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9. After a depreciation, a country's trade balance first worsens for several months and then improves steadily past its original level. The shape this path traces out is known as
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Answer: B (The J-curve effect.). Plotted against time, the trade balance dips below where it started before climbing well above it — a shape close to the letter J.
The dip happens because prices change at once while quantities take time to respond: contracts are already signed, supply chains take months to switch, and buyers need time to react. In that window the country pays more for much the same volume of imports.
As demand becomes more elastic over the following year or two, the Marshall-Lerner condition starts to be met and the balance improves. The two ideas fit together: Marshall-Lerner says whether a depreciation works, the J-curve says when.Why the other options are wrong
- A — The accelerator describes investment responding to the rate of change of demand. It has nothing to do with trade balances.
- C — The Marshall-Lerner condition is the elasticity test that decides whether a depreciation improves the balance at all. It is a condition, not a time path.
- D — The multiplier describes how an injection of spending raises national income through successive rounds.