How does a flexible exchange rate tend to correct trade deficits over time? 

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To fully understand the relationship between exchange rates and trade deficits, it's crucial to understand the meaning of each individually.

A trade deficit is defined as the total amount by which the price paid for a given country's imported goods surpasses the price paid for its exported goods. If Country X imports $3B worth of goods in a given year, but only exports $2B worth, it faces a trade deficit of $1B. With a trade deficit, there is essentially an efflux of domestic currency to other markets because it has to purchase all of that additional product that it's importing. This is also called a negative balance of trade.

An exchange rate is the value of one nation's currency when compared to that of another nation's. When quoted directly, the price paid for one unit of a foreign nation's currency is communicated as a value of the domestic currency. For instance, if the US dollar is the domestic currency and the Australian dollar is the foreign currency, a direct quote of 1.31...

(The entire section contains 3 answers and 785 words.)

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