The Global Economy: Trade, Protectionism, Exchange Rates, BoP and Integration
What the exam tests
The global economy covers trade, protectionism, exchange rates, the balance of payments and economic integration. You need comparative advantage calculations, tariff diagrams, exchange-rate transmission and evaluation of trading blocs.
Core rules
- Comparative advantage compares opportunity costs, not absolute productivity. Specialisation raises total output; terms of trade lie between the two opportunity costs.
- Tariffs raise import price and government revenue, cut consumer surplus and create deadweight loss. Quotas restrict quantity and create quota rents; subsidies lower domestic costs.
- Appreciation makes exports dearer and imports cheaper; depreciation does the reverse. The Marshall-Lerner condition says a depreciation improves the current account only if the sum of the absolute price elasticities of exports and imports exceeds 1; the J-curve describes the short-run deterioration.
- The balance of payments sums to zero: current account + capital/financial account + errors = 0. A current account deficit must be financed by inflows.
- Integration ranges from free trade areas to customs unions, common markets and monetary unions.
Worked example
Country A can produce 10 cloth or 20 wine; Country B can produce 6 cloth or 3 wine. A's opportunity cost of 1 cloth is 2 wine; B's is 0.5 wine. B has comparative advantage in cloth, A in wine. If B specialises in cloth and A in wine, mutually beneficial terms of trade lie between 0.5 and 2 wine per cloth. A tariff on cloth would protect A's inefficient cloth sector but raise domestic wine producers' input costs and reduce consumer surplus.
Traps
Do not confuse absolute and comparative advantage. A tariff and a quota both restrict imports but affect revenue differently. Do not assume a current account deficit is always bad; it may reflect investment inflows. Do not ignore the J-curve when evaluating depreciation.