International Trade, Balance of Payments, Exchange Rates and Globalisation
What the domain tests
International trade, balance of payments, exchange rates and globalisation tests comparative advantage, protection, BoP accounts, currency determination and the effects of interdependence.
Core rules
- Absolute advantage compares output per unit of input; comparative advantage compares opportunity cost. Gains from trade arise from lower opportunity cost, even if one country is absolutely better at everything.
- Protection includes tariffs, quotas, subsidies and standards. It protects domestic jobs but raises prices and can invite retaliation.
- The balance of payments records current, capital and financial accounts; it balances in accounting terms through reserve changes and errors.
- Floating exchange rates are determined by demand and supply; fixed rates are pegged; managed floats combine both.
- Depreciation makes exports cheaper and imports dearer. The Marshall-Lerner condition says the trade balance improves only if export and import demand elasticities sum to more than one; the J-curve shows a short-run worsening.
Worked example
Country A gives up 2 units of wine to produce 1 cloth; Country B gives up 0.5 units of wine. B has the lower opportunity cost in cloth, so B should specialise in cloth and A in wine. Both can consume beyond their domestic PPCs through trade. If B's currency then depreciates, its cloth exports become cheaper, but the trade balance improves only if Marshall-Lerner holds.
Traps
Comparative advantage is not absolute advantage. A current account deficit is not automatically a crisis. A depreciation does not always improve the BoP. The BoP always balances as an accounting identity; do not say it has a deficit without naming the account.