6. International economic issues

For each producer, calculate the opportunity cost of 1 unit of each good. If all resources make 30 X or 60 Y, then 1 X costs 2 Y and 1 Y costs 0.5 X. Compare the same good across producers; the lower ratio identifies comparative advantage.

Country A can make 30 X or 60 Y; Country B can make 20 X or 20 Y. A has absolute advantage in both. Yet A's cost of 1 Y is 0.5 X and B's is 1 X, so A has comparative advantage in Y; B's cost of 1 X is 1 Y versus A's 2 Y, so B has comparative advantage in X.

Both can gain only if the trading rate lies between their opportunity costs. Here, 1 X must exchange for more than 1 Y for B to gain and less than 2 Y for A to gain.

Potential benefits include better resource allocation, greater world output, economies of scale and learning, lower prices, stronger competition, wider choice, larger export markets and higher average living standards. Trade liberalisation removes barriers that prevent these exchanges.

Gains are larger when opportunity-cost differences are substantial, the exchange rate lies between the ratios, and transport and other trade costs are low. They can be reduced by barriers, adjustment costs, weak mobility, market concentration or dependence on a narrow export market.

Use index ratios, not changes in trade values or volumes. If export prices are 150 and import prices are 125 relative to the base year, TOT = 150 ÷ 125 × 100 = 120: a 20% improvement from the base index of 100.

Evaluate significance, not just number of limitations. Compare the size of the opportunity-cost gap with trade and adjustment costs, the time horizon, market structure, distribution and whether policy can reduce the constraint. A limitation can shrink or redistribute gains without removing every gain from trade.

Dumping means selling in an overseas market below production cost, or below the price charged in the exporter's home market. A low import price alone is not proof: it may reflect genuine lower opportunity cost or productivity, so costs and domestic prices must be examined.

For a tariff diagram: begin at the world price; add the tariff to obtain the higher domestic price; read lower domestic demand, higher domestic supply and a smaller import gap; tariff revenue equals tariff per unit × post-tariff imports. Removing the tariff reverses each change.

A binding quota fixes the permitted import quantity, so rising demand raises the domestic price rather than imports. A tariff keeps a tax wedge but lets import quantity respond. A higher quota is liberalisation: it increases imports and tends to lower domestic price.

Impact depends on PED/PES, access to alternative suppliers or markets, domestic capacity, whether imports are necessities or production inputs, enforcement, policy size and retaliation. Price-elastic import demand makes a tariff more likely to reduce import expenditure; inelastic demand weakens that result.

The case against protection follows the gains from free trade: comparative-advantage specialisation, greater world output, lower prices, wider choice, competitive pressure and access to larger markets. Protection creates deadweight loss, weakens efficiency incentives, may raise cost-push inflation and invites retaliation or a trade war.

Domestic protected producers and some workers may gain producer surplus and employment. Consumers usually pay more and buy less; downstream firms lose when protected imports are inputs. Government may gain tariff revenue but pays subsidies and enforcement costs. Foreign exporters and workers lose sales, while licence holders may capture quota rents.

A defensible judgement states the context and compares net effects: Is the industry genuinely infant, strategic or unfairly targeted? Is protection temporary, targeted and conditional on productivity? Are substitutes and adjustment support available? How elastic is demand, and how likely is retaliation? Developing and high-income economies can answer these questions differently.

A foreign government paying a domestic university to educate its students is a service export and credit. A resident receiving dividends from foreign shares is primary-income credit. A government donation abroad is secondary-income debit.

Treat exports and receipts as positive credits and imports and payments as negative debits. If a table already gives a balance, preserve its sign. If it gives separate flows, subtract the debit before combining components.

Goods exports 90 and imports 120 give -30. Service exports 50 and imports 35 give +15. With primary income -8 and secondary income +3: CAB = -30 + 15 - 8 + 3 = -20, a current-account deficit of 20.

Separate cyclical causes from structural ones. A temporary demand boom or commodity-price spike may reverse; persistent low productivity, narrow export dependence, weak non-price competitiveness or an overvalued currency can sustain an imbalance.

One change can work in two directions. Falling unemployment raises income and imports, but it can also raise domestic output and exports. Decide which channel dominates from spare capacity, productivity, import propensity, elasticities and the time period.

A deficit must be matched elsewhere in the balance of payments by net financial/capital inflows or reserve changes. Productive foreign direct investment financing capital imports is less concerning than unstable short-term borrowing used for consumption, although neither outcome is guaranteed.

The cause changes the verdict. A deficit caused by investment imports may expand future productive capacity; one caused by persistent uncompetitiveness is more vulnerable. A surplus driven by strong export productivity differs from one caused by a domestic recession suppressing imports.

State the quote before interpreting or converting. If £1 = €1.20 and €1 = US$1.40, then £1 = 1.20 × 1.40 = US$1.68. Reverse a quote by taking its reciprocal.

On a diagram, put the price/exchange rate of the named currency on the vertical axis and quantity traded on the horizontal axis. Downward-sloping demand and upward-sloping supply meet at the equilibrium rate; a shortage pushes the rate up and a surplus pushes it down.

For an inverted quote such as ringgit per US dollar, a rise from RM3.1 to RM4.2 per dollar means the dollar appreciates and the ringgit depreciates: more ringgit are needed to buy one dollar.

Most causes are relative. A domestic rate rise has no certain effect if foreign rates rise similarly; higher overseas income may increase demand for domestic exports and appreciate the currency; foreign trade barriers can reduce export demand and depreciate it.

Depreciation tends to help exporters using domestic inputs and import-competing firms, but hurts consumers, importers and producers reliant on foreign inputs. Appreciation broadly reverses these groups: consumers and input importers gain purchasing power while exporters face weaker price competitiveness.

Magnitude depends on export/import demand elasticities, spare capacity, import content of production, ability of domestic supply to expand, contracts and time, confidence, foreign-currency debt and the size/persistence of the rate change.

Judge an imbalance by its size and persistence, its cause, how it is financed, debt-service capacity and future export income. A temporary deficit financing productive investment can be more sustainable than one financing repeated consumption; a temporary commodity-led surplus need not justify immediate correction.

To reduce a surplus, reverse the expenditure direction: expansionary fiscal or monetary policy can raise domestic spending and imports. Measures that appreciate the currency can make exports less competitive and imports cheaper. Removing protection or export support may also reduce the surplus, but each choice affects inflation, growth and employment.

Choose by cause and horizon. Demand restraint fits an import-heavy spending boom and can work relatively quickly; supply-side policy better addresses weak productivity but takes time; protection can cut selected imports quickly but risks retaliation. Effectiveness depends on export/import PED and PES, spare capacity, import content, exchange-rate reactions, trading-partner growth and whether policies are combined.