Unit 3: International Economics - Trade, Protection and Exchange Rates
Core concepts to master
Unit 3 examines how economies interact through trade and finance. You must understand comparative advantage, the gains from specialisation and trade, and the difference between absolute and comparative advantage. Know the tools of protection (tariffs, quotas, subsidies, local-content rules) and be able to analyse their effects on domestic consumers, producers, government revenue and world allocative efficiency using a simple supply-and-demand diagram described in words. Understand Australia's trade pattern - major exports (iron ore, coal, LNG, education, tourism), major trading partners, and the role of the terms of trade. For the balance of payments, distinguish the current account (goods, services, primary and secondary income) from the capital and financial account, and explain how a floating currency adjusts.
Traps examiners set
- Confusing a movement along the demand/supply curve (price change) with a shift (non-price factor).
- Claiming a tariff always raises welfare because it protects jobs - always weigh deadweight loss and retaliation.
- Mixing up appreciation (currency buys more foreign currency) with an increase in the exchange rate quoted as foreign currency per unit of domestic currency.
- Forgetting that a depreciation improves the trade balance only if the Marshall-Lerner condition holds (elasticities of exports plus imports exceed one).
Worked rule of thumb
When asked to evaluate protection, structure your answer: (1) identify the policy and its mechanism; (2) state the winners and losers; (3) quantify the net efficiency effect conceptually (consumer surplus lost versus producer surplus and revenue gained); (4) conclude with a judgement tied to the question's context. For example, a tariff on imported steel raises domestic price, boosts domestic producer surplus, generates revenue, but reduces consumer surplus by more than the sum of gains, creating deadweight loss.