International Trade, Balance of Payments, Exchange Rates, Globalisation, Development and EU Policy
This section covers international trade, the balance of payments, exchange rates, globalisation, development and EU economic policy. The exam tests comparative advantage, current account interpretation and exchange-rate effects.
Core rules
- Absolute advantage means producing more with the same resources; comparative advantage means a lower opportunity cost. Gains from trade follow comparative advantage.
- The current account records goods, services, income and transfers. The financial account records investment flows; the capital account covers capital transfers and non-produced assets. The balance of payments must balance overall.
- A current account deficit is financed by inflows on the financial account. It is not automatically a sign of weakness.
- Exchange rates can be fixed, floating or managed. Appreciation makes exports dearer and imports cheaper; depreciation does the reverse.
- Globalisation increases cross-border flows of goods, capital, people and information. Development is broader than GDP growth: the HDI includes health and education.
- EU policy includes the Single Market's four freedoms, euro-area monetary policy, cohesion funding and fiscal surveillance.
Worked example
Goods exports €20bn, goods imports €15bn, services exports €10bn, services imports €8bn, income outflows €4bn, transfers inflow €1bn. Current account = 20 minus 15 plus 10 minus 8 minus 4 plus 1 = €4bn surplus. This surplus must be matched by net financial outflows or reserve changes.
Traps
Do not confuse comparative and absolute advantage. Do not call a current account deficit a loss. Do not confuse a currency appreciation with a rise in export competitiveness. Do not treat the balance of payments as only the trade balance.