International Trade

Section: International Trade and Capital Flows Estimated study time: 60 minutes Content: International trade theory at CFA Level 2 provides the analytical framework for understanding trade patterns, trade policy effects, and the balance of payments. Comparative advantage — the ability to produce a good at a lower opportunity cost than a trading partner — is the foundation of trade theory. Even if one country has absolute advantage in all goods, both countries can benefit from specialization and trade based on comparative advantage. The Ricardian model demonstrates that countries should export goods in which they have the lowest relative production cost and import goods in which they have the highest. The Heckscher-Ohlin model extends this by arguing that countries export goods that intensively use their abundant factors (labor-abundant countries export labor-intensive goods; capital-abundant countries export capital-intensive goods). Trade restrictions take several forms: tariffs (taxes on imports), quotas (quantitative limits on imports), export subsidies, and non-tariff barriers (regulatory requirements, standards). The effects of a tariff on a small, price-taking economy are well-defined: domestic price rises by the tariff amount; domestic consumption falls; domestic production rises; imports fall; government collects tariff revenue; consumer surplus falls by more than the sum of tariff revenue and producer surplus gain — the difference is the deadweight loss, representing the efficiency cost of the tariff. A quota has similar effects on price and quantity but distributes the quota rent to import license holders rather than the government. At Level 2, candidates must calculate and compare welfare effects across these trade restriction types. The balance of payments (BOP) is an accounting framework that records all economic transactions between a country's residents and the rest of the world.…