International Trade and Finance
Core Concepts
International trade covers comparative advantage, trade barriers (tariffs, quotas), trade agreements, balance of payments, exchange rates, and capital flows. You must understand the Ricardian and Heckscher-Ohlin models, terms of trade, and the Marshall-Lerner condition. Exchange rate regimes (fixed, floating, managed) and their implications for policy are crucial. For Bangladesh, RMG exports, remittances, and trade deficits are key.
Common Traps
- Confusing absolute and comparative advantage; trade benefits from comparative advantage.
- Forgetting that a tariff raises domestic price, reduces imports, and creates deadweight loss.
- Misapplying the Marshall-Lerner condition: a currency depreciation improves trade balance only if sum of export and import demand elasticities > 1.
- Assuming balance of payments always balances; it does in accounting sense, but components can be in surplus/deficit.
- Overlooking that remittances are unilateral transfers, not exports.
Worked Example / Rule of Thumb
Rule of thumb: Comparative advantage: a country should specialize in goods for which it has a lower opportunity cost. If Country A can produce 1 unit of cloth with 2 hours and 1 unit of wine with 4 hours; Country B can produce 1 cloth with 3 hours and 1 wine with 5 hours. Opportunity cost of cloth: A = 2/4 = 0.5 wine; B = 3/5 = 0.6 wine. A has comparative advantage in cloth. Opportunity cost of wine: A = 4/2 = 2 cloth; B = 5/3 ≈ 1.67 cloth. B has comparative advantage in wine. They should trade.
Example: Suppose world price of cloth is 1 wine. A specializes in cloth, produces 1 cloth (2 hours) and trades for 1 wine, which would have taken 4 hours to produce domestically. Gain = 2 hours. B specializes in wine, produces 1 wine (5 hours) and trades for 1 cloth, which would have taken 3 hours domestically. Gain = 2 hours. Both gain from trade.