Government spending and net trade

Influences on government expenditure (G)

• Fiscal policy: governments raise spending to boost AD or cut it to reduce a budget deficit.
• Level of economic activity: in a recession, spending on benefits rises automatically (though transfers are not part of G itself, they show the budget pressure).
• Correction of market failures: spending on merit and public goods such as health, education, defence and street lighting.
• Political priorities: electoral promises, ageing populations, infrastructure plans.

Note: in AD, G is spending on goods and services; transfer payments such as pensions and benefits are not included, as no output is bought.

Influences on the net trade balance (X - M)

• Real income: higher domestic incomes raise imports (worsening X - M); higher incomes abroad raise exports.
• Exchange rate: a depreciation makes exports cheaper abroad and imports dearer at home, so X - M usually improves (if demand is price elastic enough). An appreciation does the opposite.
• State of the global economy: a world recession cuts demand for exports.
• Protectionism: tariffs and quotas abroad cut exports; at home they cut imports.
• Non-price factors: quality, design, reliability, branding and after-sales service affect competitiveness.

Using net trade in AD answers

A rise in X - M shifts AD right. Use real-world context: an economy that relies on exports of oil or tourism is hit hard if world demand falls. A depreciation helps net trade only gradually, because contracts are fixed in the short run.

Worked example

The currency of Country Z depreciates by 15%. Explain the likely effect on Z's AD.

1. Z's exports become cheaper in foreign currency, so export volumes rise.
2. Imports become dearer in Z's currency, so Z's residents buy fewer imports and more domestic goods.
3. X - M rises, so AD shifts right (assuming demand is price elastic enough).

Answer: Net trade improves, shifting AD to the right.

Check yourself

1. Exports are $420 bn and imports are $465 bn. Find net trade in $ bn.
   Show answer

   -45 bn. X - M = 420 - 465 = -$45 bn.

2. C = 700, I = 160, G = 240, X = 300, M = 330 ($ bn). Find AD in $ bn.
   Show answer

   $1070 bn. 700 + 160 + 240 + (300 - 330) = $1,070 bn.

3. Which is NOT counted as G in aggregate demand?
   • Salaries of public sector nurses
   • Building a new motorway
   • Buying military equipment
   • State pension payments
   Show answer

   State pension payments. Pensions are transfer payments: no good or service is bought in return.

4. A rise in real incomes in a country's main trading partners will most likely
   • raise its exports and improve net trade
   • raise its imports and worsen net trade
   • have no effect on net trade
   • cause its currency to depreciate
   Show answer

   raise its exports and improve net trade. Richer customers abroad buy more exports.

5. An appreciation of the currency is most likely to
   • improve net trade
   • raise exports
   • worsen net trade
   • make imports more expensive
   Show answer

   worsen net trade. Exports become dearer abroad and imports cheaper at home.

6. Which is a non-price factor that could raise a country's exports?
   • Better product quality and reliability
   • A depreciation
   • A cut in export prices
   • Lower tariffs on imports
   Show answer

   Better product quality and reliability. Quality is a non-price factor in competitiveness.

7. An ageing population is most likely to lead governments to increase spending on
   • primary schools
   • defence
   • health care
   • export subsidies
   Show answer

   health care. Older people use more health services, a political and social priority.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.