International Trade, Balance of Payments and Exchange Rates
This section covers trade gains, protection, the balance of payments and exchange-rate movements, which the exam tests through comparative advantage, BOP accounts and appreciation/depreciation effects. You need to separate absolute from comparative advantage.
Core rules
- Absolute advantage means producing more with the same resources. Comparative advantage means lower opportunity cost. Trade can benefit both countries even if one has absolute advantage in both goods.
- The balance of payments records all transactions. Current account includes goods, services, primary income and transfers. Capital and financial accounts record investment flows and reserves.
- The BOP identity means the accounts must balance overall, but individual balances can be in deficit or surplus.
- A depreciation lowers the external value of a currency. Exports become cheaper abroad; imports become dearer at home.
- A depreciation may not improve the trade balance immediately because of the J-curve; the Marshall-Lerner condition requires export and import elasticities to be sufficiently high.
- Protection includes tariffs, quotas, subsidies and administrative barriers.
Worked example
Country A can produce 10 rice or 5 cloth; Country B can produce 6 rice or 4 cloth. A’s opportunity cost of 1 cloth is 2 rice; B’s is 1.5 rice. B has comparative advantage in cloth; A has comparative advantage in rice. A should specialise in rice and trade for cloth, even though A has absolute advantage in both goods. If the exchange rate moves from 1 USD = 2,100 MMK to 2,200 MMK, the kyat depreciates: a 21,000 MMK export was $10 and is now about $9.55.
Traps
Do not confuse absolute with comparative advantage; do not say the BOP never has deficits; do not assume depreciation always helps immediately; do not omit services and transfers from the current account.