International Trade and Balance of Payments
International Trade and Balance of Payments covers why countries trade and how transactions are recorded. BIEAP tests absolute and comparative advantage, trade policy instruments, exchange rates and BoP accounts.
Core rules
- Absolute advantage means producing more with the same resources; comparative advantage means lower opportunity cost.
- Countries gain from specialisation according to comparative advantage, even if one country has an absolute advantage in both goods.
- Tariffs are taxes on imports; quotas limit quantities; subsidies support domestic producers.
- The current account records goods, services, income and transfers. The capital and financial account records investment and borrowing flows.
- The BoP always balances in accounting terms because of reserve changes; a “deficit” usually refers to the current account.
- Devaluation lowers the external value of a currency under a fixed regime; depreciation is a market-driven fall. Both can improve export competitiveness.
Worked example
Country A can produce 10 cloth or 20 wheat; Country B can produce 6 cloth or 12 wheat. A’s opportunity cost of 1 cloth is 2 wheat; B’s is also 2 wheat. No comparative advantage exists in this simplified case, so specialisation gains are absent unless costs differ.
Traps
Do not confuse absolute and comparative advantage. A favourable BoP does not mean every account is in surplus. Do not call depreciation devaluation. The current account includes services and transfers, not only goods. Tariffs raise revenue but also raise domestic prices.