Question

At Christmas, seven-year-old Isabel runs a massive trade deficit with her parents: She “exports” only a wrapped candy cane to her parents, but she “imports” a massive number of video games, dolls, and pairs of socks. EXPLAIN

1. Is this trade deficit a good thing for Isabel?
2. When Isabel turns 25, her parents insist on being repaid for all those years of Christmas presents—that is, they require her to run a “trade surplus.” Is this “trade surplus” good news for Isabel? Why or why not?

Answer 1

Here we can say that Isabel is a developing or under developed country which depends largely on foreign imports in its initial growth stage . High demand for imports means that there is high demand for foreign currency , this causes appreciation of foreign currency or relative fall in value of domestic currency .

This trade deficit is not a good thing , since it reflects as a deficit in current account and also depreciates the domestic currency . Foreigners own more domestic assets and domestic industries become weaker , When Isabel turns 25 , she has to pay back this deficit . This can be done by either depreciating the exchange rate or raising productivity and exchange . This is also a burden on the country since depreciating exchange rate to increase exports and decrease imports causes fall in value of domestic currency .