Economic Expansion and The Balance of Trade: The Role of Aggregate Demand Elasticity

Abstract

This paper investigates the role of aggregate demand elasticity for the balance of trade when economic expansion occurs. We have two conclusions. First, when an economic expansion results from an increase of aggregate demand, the balance of trade deficit is larger the less elastic is aggregate demand with respect to the general price level. Second, when an economic expansion happens from an increase of short-run aggregate supply, the price level elasticity of aggregate demand determines both the direction of change of the balance of trade and the size of the resulting deficit or surplus. We show here that a relatively elastic aggregate demand can result in a balance of trade deficit, while a relatively inelastic aggregate demand can yield a balance of trade surplus.