Understand What Is Balance of Trade: As common people, most of the time, we make budgeting of our income and expenses to know what our current financial position is. Similarly, for every country, it is very much essential to keep track of all the revenues and expenditures, imports and exports, and all types of transactions that are done during a financial year to know the financial as well as economic position of the country.
For this purpose, each country uses a statement known as the Balance of Payment and the Balance of Trade is an important component of it. But what exactly is a Balance of Payments? How should you interpret the Balance of Trade? In this blog, this is exactly what we are going to discuss. Keep reading to find out more!
What Do You Mean By Balance Of Trade?
The Balance of trade is the difference between the country’s value of exports and the country’s value of imports for any given period. Also known as trade balance, it always takes into consideration only the physical goods.
Physical goods here means all types of commodities like food grains, pharmaceuticals, textiles, crops, electronic goods, etc.
The balance of trade forms the major component of the country’s balance of payment and helps in finding out the net profit or loss incurred by exporting and importing goods.
What Is Balance Of Trade?
Let us take an example of what is balance of trade. If we earn more income and still our expenses remain the same or sometimes less, then we can have extra savings for ourselves. Similar will be the case in a country where goods and services are exchanged across borders.
If a country exports more goods than it imports in a given period it is known as a trade surplus. On the contrary, if a country’s import of goods and services is higher than what it exports, it is known as a trade deficit.
A country with a trade surplus indicates that it is highly productive and financially stable. While a country with a trade deficit indicates that it is highly dependent on imports. It is the reason why foreign policies of the country are always trying to formulate policies that encourage more and more exports.
Importance Of Balance Of Trade
The balance of trade is one of the key metrics to know the economic stability of the country. It is used to find out whether a country has a favourable balance of trade or not. A trade balance is said to be favourable if the country has more exports than imports and vice versa in case of an unfavourable balance of trade.
Although the balance of trade alone does not indicate the economic stability of a country, as the overall economic stability depends on several factors like trade policies and regulations related to it, availability of technology, labour, etc. Trade balance is one of the important factors in determining the productivity of a country.
Types Of Balance Of Trade
The balance of trade is broadly classified into 3 types namely
- Favourable balance of trade
- Unfavourable balance of trade
- Equilibrium balance of trade
- Favourable Balance Of Trade:
A favorable balance of trade, or trade surplus generally occurs when the country’s exports are more than the imports for that particular period. This implies that the country is generating more income from exports to other countries.
But in the broader sense, the trade surplus is a result of several factors such as competitive advantages in manufacturing certain goods, and the availability of raw materials at lower costs leading to an increase in production along with higher exports. The trade surplus indirectly helps in improving the overall economy of the country.
Let us try to understand it more clearly with the help of an example. If a country has to increase exports, then it should naturally produce more goods than usual and for more production, the industries have to hire more workers which indirectly increases employment in the country.
Employment obviously leads to a reduction in poverty. This is how the trade surplus obtained by maximising exports helps in the economic development of the country.
- Unfavourable Balance Of Trade:
An unfavourable balance of trade or trade deficit generally occurs when the country’s imports are more than the exports for a particular period. The trade deficit shows that the country is spending most of its revenue on importing goods from other countries.
Even though excessive imports may show the dependence of a country on imported goods at first glance, it may not be the real cause in the practical sense. Most of the time, goods are imported due to the competitive disadvantage of the importing country and the unavailability of raw materials to manufacture the goods.
Let us understand it easily with the help of an example. If we consider the import of natural resources like manganese or iron ore, it is essential to do so, because they cannot be manufactured. In such cases, the import of goods may be necessary leading to trade deficits.
- Equilibrium Balance Of Trade:
The equilibrium balance of trade is a situation where the country’s exports are equal to the country’s imports.
Calculation Of Balance Of Trade:
The balance of trade is calculated by subtracting the total value of import of goods from the total value of export of goods.
Balance of trade = Total Exports of Goods – Total import of goods
For example, In Canada for the year 2021, if the total value of exports is $ 8 billion and the total value of imports of $ 5 billion, then the balance of trade OR trade surplus is $ 3 billion
Balance of trade = $ 8 billion – $ 5 billion
= $ 3 billion
If the balance of trade is negative, then it is the trade deficit.
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How is The Balance Of Trade Measured?
Another important thing to remember here is that the Balance of Trade is always measured in the currency of the country whose balance of trade is calculated. For example, here we have taken Canada as an example. Hence trade balance is measured in Canadian dollars.
Balance Of Payments vs Balance Of Trade
Most of the time, people get confused between the terms balance of payments and balance of trade. Let us try to understand it more clearly.
The balance of payments and the balance of trade are interconnected with each other. In a broader sense, the balance of trade is one of the components in calculating the balance of payment. To have a more clear idea let us see the key differences between the balance of payments and the balance of trade
Basis Of Differences | Balance Of Trade | Balance Of Payments |
Purpose | Balance of trade helps in finding the net profit or loss incurred by the export or import of goods. | Balance of payments helps in accounting for all the transactions that take place within and outside the country. |
Consideration | It considers the export and import of only physical goods for a particular period. | It considers the exports and imports of all goods, services, unilateral transfers and capital accounts. |
Differences | It is the difference between the export and import of goods. | It is the difference between the outflow and inflow of foreign exchanges. |
This is an image showing the comparison of Imports and exports of both goods and services by India for the financial years 2022 and 2023 along with the interpretation of results.
Source: Ministry of Commerce and Industry, Government of India
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Closing Thoughts
In this blog on the What Is Balance of Trade & Its Types, Importance & Calculation, we have discussed in detail the meaning and importance of the balance of trade, the types of balance of trade, and the method of its calculation. Hope this helps you in understanding the concept of balance of trade and helps you to know the country’s current economic status as a responsible citizen. Happy reading!
FAQ
1. What is trade deficit?
Trade deficit occurs when a country imports more goods and services than it exports. In other words, it represents a negative balance of trade for a country.
2. What is surplus in simple words?
Surplus refers to the amount by which a quantity or resource exceeds what is necessary or required. In an economic context, a surplus occurs when a country exports more goods and services than it imports, resulting in a positive balance of trade.
3. What are the features of balance of trade?
The features of balance of trade include the difference between a country’s exports and imports, its impact on the country’s currency, its role in international trade, and its importance in measuring a country’s economic performance.
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