International Trade, Balance of Payments and Exchange Rates
International trade tests comparative advantage, trade barriers, the balance of payments and exchange rates. The exam expects clear distinction between absolute and comparative advantage and between a current account deficit and a balance of payments deficit.
Comparative advantage
Absolute advantage means producing more with the same resources. Comparative advantage means producing at lower opportunity cost. Even if one country has absolute advantage in both goods, both can gain if each specialises where its opportunity cost is lower and they trade at a terms of trade between their internal opportunity costs.
Trade barriers and integration
Tariffs raise import prices and revenue; quotas limit quantity; subsidies help domestic exporters; embargoes ban trade. Protection may protect infant industries and jobs but raises consumer prices and can provoke retaliation. CEMAC is a customs union; AfCFTA aims to expand intra-African trade.
Balance of payments
The current account records goods, services, income and transfers. The capital and financial account records investment and loans. The balance of payments always balances in accounting terms because of the errors and omissions item; a current account deficit must be financed by inflows or reserves. A deficit is not automatically a crisis.
Exchange rates
Depreciation is a market fall in a floating currency; devaluation is a deliberate fall under a fixed rate. The CFA franc is pegged to the euro at 1 euro = 655.957 CFA and was devalued in 1994. A weaker currency makes exports cheaper but imports dearer, which can worsen inflation.
Worked example
Cameroon can produce 1 tonne of cocoa or 3 tonnes of maize with one unit of resources; Nigeria can produce 1 tonne of cocoa or 2 tonnes of maize. The opportunity cost of 1 cocoa is 3 maize in Cameroon and 2 maize in Nigeria, so Nigeria has a comparative advantage in cocoa. Cameroon has a comparative advantage in maize (1 maize costs 1/3 cocoa versus 1/2 in Nigeria). If they trade at 1 cocoa for 2.5 maize, both gain compared with producing both goods themselves.
Traps that cost marks
Do not confuse absolute with comparative advantage; do not say the balance of payments can never be in deficit; and do not confuse depreciation with devaluation. Also avoid claiming a tariff always improves welfare, and remember that a current account deficit may reflect strong investment.