Signing more free trade agreements is likely to increase aggregate demand even if it leads to a greater increase in imports than exports.

Introduction

A free trade agreement (FTA) is an agreement between two or more economies to remove or reduce barriers to trade with the objective of increasing the cross-border movement of goods and services between the economies. Exports are the expenditure made by foreigners on domestic goods and services. Imports are the expenditure made by domestic residents on foreign goods and services. Aggregate demand is the total demand for the goods and services produced in the economy over a period of time and is comprised of consumption expenditure, investment expenditure, government expenditure on goods and services and net exports.

Many students think that signing more free trade agreements will not increase aggregate demand if it leads to a greater increase in imports than exports. This economic misconception will be discussed in economics tuition.

Exposition

Take Singapore for example. When tariffs on Singapore’s goods are removed or reduced in the FTA member countries, firms that import and sell Singapore’s goods in the FTA member countries will decrease prices to maintain competitiveness. Therefore, signing FTAs in Singapore will make Singapore’s goods cheaper in the FTA member countries. When this happens, exports in Singapore to the FTA member countries will increase. As exports are a component of aggregate demand, an increase in exports will lead to an increase in aggregate demand. Signing FTAs in Singapore will also make goods from the FTA member countries cheaper in Singapore due to the removal or reduction in tariffs on the goods. Therefore, if Singapore signs more FTAs, imports from the FTA member countries will increase. However, imports are foreign goods and services which are produced in other economies. As aggregate demand refers to the total demand for the goods and services produced in the economy, an increase in imports per se will not affect aggregate demand. However, signing FTAs in Singapore will make goods from the FTA member countries relatively cheaper than domestic goods resulting in a substitution of imports for domestic goods. When this happens, the demand for domestic goods will fall which will lead to a decrease in aggregate demand. This effect, however, is unlikely to be significant. In many economies including Singapore, there is limited overlap between imports and domestic goods. Therefore, cheaper imports from the FTA member countries are unlikely to have a significant effect on the demand for domestic goods and hence are unlikely to lead to a significant decrease in aggregate demand. It follows that even if signing more free trade agreements leads to a greater increase in imports than exports, aggregate demand is likely to rise.

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