International Economics and Trade
International Economics and Trade tests comparative advantage, the welfare effects of trade policy, balance-of-payments accounting, and exchange-rate determination. The exam expects you to separate efficiency gains from distributional effects and to use consistent credit–debit logic.
Core rules and concepts
- Comparative advantage is based on opportunity cost. A country gains from trade by specializing where its opportunity cost is lower, even without an absolute advantage.
- Tariffs in a small country raise the domestic price to the world price plus the tariff. Consumer surplus falls, producer surplus rises, government collects revenue, and deadweight loss arises from overproduction and underconsumption.
- Balance of payments: current account + capital account + financial account = 0 in the standard identity. Exports and income receipts are credits; imports and income payments are debits.
- Exchange rates: the nominal rate is the quoted rate; the real rate adjusts for relative prices. Purchasing-power parity is a long-run anchor, not a short-run prediction.
- Interest parity links expected exchange-rate changes to interest differentials. The Marshall–Lerner condition says a depreciation improves the trade balance if export and import demand elasticities are sufficiently large; the J-curve describes the short-run delay.
Worked example
A small country faces world price 10. Domestic demand is Qd = 100 − 2P and supply is Qs = 20 + 2P. Under free trade at P = 10, Qd = 80 and Qs = 40, so imports are 40. A tariff of 3 raises the domestic price to 13: Qd = 74, Qs = 46, and imports are 28. Consumer-surplus loss is ½ × (80 + 74) × 3 = 231. Producer-surplus gain is ½ × (40 + 46) × 3 = 129. Tariff revenue is 3 × 28 = 84. Deadweight loss is 231 − 129 − 84 = 18, equal to ½ × 3 × 6 plus ½ × 3 × 6.
Traps that cost marks
Do not confuse absolute and comparative advantage. Tariff revenue is not a welfare gain once consumer and producer effects are counted. Keep balance-of-payments credits and debits consistent. Nominal depreciation is not real depreciation. PPP can fail for years because of tradables, transport costs, and capital flows. Quota rents accrue to licence holders unless captured by the government.