Let imports exceed exports by $100 billion. Compared with a situation of balanced trade at the same level of GDP, domestic income is
A) lower than it would have been otherwise by the full $100 billion.
B) higher than it would have been otherwise by the full $100 billion.
C) lower than it would have been otherwise by an amount reflecting debt service on the foreign borrowing required to finance the $100 billion trade deficit.
D) higher than it would have been otherwise by an amount reflecting the interest earnings accruing to domestic importers in exchange for opening new markets.
E) the same as it would have been otherwise.

Question

Quizplus · Accepted Answer

When a country has a trade deficit, meaning imports exceed exports by a certain amount (in this case, $100 billion), it often needs to borrow from abroad to finance this deficit. The domestic income is then lower than it would have been otherwise, not by the full amount of the trade deficit, but by an amount reflecting the debt service (interest and principal payments) on the foreign borrowing required to finance the trade deficit. This is because the country has to allocate a portion of its income to service this debt.

Let Imports Exceed Exports by $100 Billion