Question

Use the national income identity equation, (S-I) = (X-M), to analyze the potential effectiveness of reducing import barriers in order to try and reduce current account surplus. In particular, explain how lower import barriers might prove completely ineffective in reducing a trade surplus.

Answer 1

National income identity equation, Y = C+I+G+(X-M)

where C stands for consumption, I stands for investment, G stands for government expenditure or spending, X stands for exports and M stands for imports. When there are lower import barriers, then the level of imports in any country increases. Such an increase lowers Net exports, that is, (X-M) falls and thereby leads a decline in national income of the country. Moreover, trade surplus which is defined as excess of exports over imports might or might not fall because there may be an increase in exports as well. Therefore, lower import barriers prove to be completely ineffective in reducing trade surplus.