International Economics and Economic Development
This domain tests gains from trade, trade barriers, exchange-rate mechanics, the balance of payments, and how economists measure and explain development.
Core rules
- Trade follows comparative advantage (lowest opportunity cost), not absolute advantage. With specialization and a terms-of-trade price between the two domestic opportunity costs, both partners gain.
- Tariffs are taxes on imports; quotas limit import quantity. Both raise the domestic price and cut consumer surplus. Tariffs generate government revenue; quotas generate quota rents. Both create deadweight loss from overproduction and reduced consumption.
- Currency appreciation makes exports dearer abroad and imports cheaper at home, reducing net exports; depreciation does the reverse. Interest-rate differentials, inflation, growth, and expectations drive exchange rates; purchasing power parity holds better in the long run.
- Balance of payments: current account (goods, services, income, transfers) plus financial/capital account plus statistical discrepancy sums to zero. A current account deficit is matched by net capital inflow.
- Development: GDP per capita at PPP measures income; the HDI blends health, education, and income; the Gini coefficient measures inequality. Growth depends on capital, labor, human capital, technology, and institutions such as property rights and the rule of law. Import substitution and export orientation are rival strategies; evidence on aid, microfinance, and FDI is mixed.
Worked example
The dollar appreciates from $1.20 per euro to $1.00 per euro. A $120 U.S. machine that cost euro-area buyers €100 now costs €120, a 20% increase. Exports become less competitive and imports become cheaper, so net exports fall. Reasoning: appreciation means fewer dollars per unit of foreign currency, so foreign buyers need more of their own currency for U.S. goods.
Traps
Treating trade as zero-sum; reversing the direction of appreciation and depreciation; recording capital inflows in the current account; equating GDP per capita with development; assuming foreign exporters absorb a tariff rather than domestic consumers and importers.