LEARNING OBJECTIVES
What you will be able to do
- explain specialisation and comparative trade benefits
- evaluate trade protection
- analyse exchange-rate demand, supply and changes
- interpret current-account balances and policy responses
AT A GLANCE
INTRODUCTION · THE BIG IDEA
Explain trade patterns, protection, exchange rates and current-account outcomes.
International trade allows countries to consume beyond their own production possibilities by specialising and exchanging. Benefits are not automatic or equally distributed, and dependence creates exposure to global shocks.
Exchange rates connect domestic and foreign prices, while the current account records major flows of goods, services, income and transfers.
SECTION 01
Specialisation and free trade
Countries specialise because climate, resources, skills, technology and costs differ. Trade can increase choice, competition, scale and access to inputs. Comparative advantage means specialising where opportunity cost is lower, even if one country is more productive in everything.
Costs include structural unemployment, transport emissions, infant-industry pressure, dependence and exposure to world price or supply changes. Gains depend on terms of trade, worker mobility and how income is distributed.
SECTION 02
Trade protection
A tariff is a tax on imports, a quota limits quantity, a subsidy lowers domestic producers' costs and an embargo bans trade. Administrative rules and standards can also restrict imports.
Protection may defend infant or strategic industries, jobs, standards or the current account. It can also raise prices, reduce choice, shelter inefficiency, provoke retaliation and harm exporters. A temporary, targeted measure is easier to justify than permanent protection without improvement.
| Method | Direct effect | Likely issue |
|---|---|---|
| Tariff | raises import price | consumer cost and retaliation |
| Quota | limits import quantity | shortage and licence allocation |
| Subsidy | lowers domestic cost | taxpayer opportunity cost |
| Embargo | stops specified trade | severe supply and diplomatic effects |
SECTION 03
Exchange rates
In a floating system, currency demand comes from foreigners buying exports or assets, while supply comes from residents buying imports or foreign assets. Export demand, import demand, interest rates, investment flows, speculation and confidence can change the rate.
Appreciation makes exports dearer abroad and imports cheaper at home; depreciation does the reverse. The effect on the current account depends on demand elasticity, production capacity, imported inputs and time.
Currency conversion
- The exchange rate is €1 = $1.25.
- A traveller converts $750 to euros.
- Euros = 750 ÷ 1.25.
Answer: The traveller receives €600 before fees.
SECTION 04
Current account and global interdependence
The current account includes trade in goods, trade in services, primary income such as profit and interest, and secondary income such as transfers. A deficit means current-account payments exceed receipts; it is financed by financial flows or reserve changes.
A deficit may reflect strong investment and growth or weak competitiveness and excessive consumption. Policies include depreciation, demand reduction and supply-side improvements. Each has drawbacks: slower growth, inflation or long time lags.
Globalisation links production, finance and communication. Multinational firms can spread capital, jobs and technology but may shift profit, influence policy or create environmental and labour concerns.
QUICK CHAPTER SUMMARY
The ideas to carry forward
- Trade allows specialisation by comparative advantage.
- Protection helps some groups while imposing costs on others.
- Exchange rates respond to currency demand and supply.
- Current-account balances need diagnosis before policy judgement.
QUICK REVISION CHECKLIST
Can you do each of these without your notes?
- explain specialisation and comparative trade benefits
- evaluate trade protection
- analyse exchange-rate demand, supply and changes
- interpret current-account balances and policy responses