The objective of this simulation is to investigate how the exchange rate will influence the trade balance (exports minus imports) on the Balance of Payments. The simulation also accounts for the Marshall-Lerner principle.

The input variables include the price elasticity of demand for imports and exports, the original quantity of imports and exports and the change in the exchange rate.

The output area includes the original and new trade balance, and the new level of exports and imports.

The UK's trade balance is the value of UK exports minus the value of UK imports. The pattern of the UK trade balance appears to be fluctuating. For instance, in 1989 the current account was in deficit by £20807 million, however, by 1997 the current account became a surplus of £504 million.

To understand why the trade balance has fluctuated we need to understand what determines the quantity of imports and exports. The determinants of demand for an import or export include;

• Price (the exchange rate)
• Level of Income
• Price of substitutes and complements
• Tastes & fashions

You can download an Excel version of the original spreadsheet (Excel 97)

The model determines how the level of exports and imports will change for a given change in the exchange rate. The basic relationship assumes that the level of exports is negatively related to the exchange rate, therefore, if the exchange rate increases (appreciates) then the level of exports will fall. The model assumes that the level of imports and the exchange rate are positively related. Therefore, an increase in the exchange rate will cause and increase in the level of imports.

The modeller is able to set the price elasticities of demand for imports and exports, the original level of imports and exports and the percentage change in the exchange rate.

Keep up to date with the UK's trade balance, visit, www.statistics.gov.uk.

The model settings for the inputs are;

• Price Elasticity of Demand for Imports: 0.00 to 2.00
• Price Elasticity of Demand for Exports: 0.00 to 2.00
• Original Quantity of Imports (£): 0 to 20.00
• Original Quantity of Exports (£): 0 to 20.00
• Percentage change in the exchange rate (%): -20 to 20

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