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CFA® Level I · Economics · free lesson
International Trade
Tariffs, trade agreements and current account imbalances shape company margins, sector winners and losers, and currency trends. This module explains why countries gain from trade and who loses, how tariffs, quotas and export subsidies redistribute income and destroy value, how trading blocs from free trade areas to monetary unions work, how the balance of payments records a country's transactions with the world, and what the IMF, World Bank and WTO do.
What you will learn
1. Describe the benefits and costs of international trade, and explain absolute and comparative advantage and the Ricardian and Heckscher-Ohlin models of trade.
- Benefits: specialization, scale, variety, lower prices, competition and technology transfer.
- Costs: job and income losses concentrated in import-competing industries and regions.
- Comparative advantage = lower opportunity cost; it, not absolute advantage, drives gains from trade.
- Ricardian model: differences in labour productivity (technology).
- Heckscher-Ohlin model: differences in factor endowments; trade raises returns to the abundant factor.
2. Compare tariffs, import quotas, export subsidies and voluntary export restraints, and calculate and interpret their effects on prices, quantities and economic welfare.
- Tariff = tax on imports; quota = quantity limit; VER = quota set by the exporter; export subsidy = payment for exporting.
- A tariff raises the domestic price: consumers lose, producers gain, government collects revenue.
- Deadweight loss = consumer loss - producer gain - tariff revenue.
- A quota with the same price effect turns tariff revenue into quota rent; under a VER the rent goes abroad.
- Large countries may improve their terms of trade with tariffs, but retaliation can erase the gain.
3. Explain the motivations for and advantages of trading blocs, and distinguish free trade areas, customs unions, common markets, economic unions and monetary unions.
- Free trade area: no internal barriers, separate external tariffs, rules of origin.
- Customs union adds a common external tariff; common market adds free movement of labour and capital.
- Economic union adds common institutions and policy coordination; monetary union adds a common currency.
- Trade creation (gain) versus trade diversion (loss) decides the welfare effect.
- Deeper integration means larger markets but less national policy independence.
4. Describe the current, capital and financial accounts of the balance of payments and explain how decisions by households, firms and governments affect the current account.
- Current account: goods, services, primary income and secondary income.
- Capital account: capital transfers and non-produced, non-financial assets; usually small.
- Financial account: direct, portfolio and other investment and reserve changes.
- A current account deficit is financed by a financial account surplus.
- CA = (private saving - investment) + (taxes - government spending).
5. Describe the functions and objectives of the International Monetary Fund, the World Bank Group and the World Trade Organization.
- IMF: surveillance, conditional lending for balance of payments problems, technical assistance; stability of the monetary system.
- World Bank Group: long-term finance and expertise to reduce poverty and support development.
- WTO: trade rules based on non-discrimination, negotiations, dispute settlement and monitoring.
- GATT (1947) preceded the WTO, which was created in 1995.
- Short-term financial stability = IMF; long-term development = World Bank; trade rules = WTO.
Module at a glance
- Comparative advantage, based on opportunity cost, drives gains from trade even with absolute disadvantage.
- Ricardian model: productivity differences; Heckscher-Ohlin: factor endowments and internal winners and losers.
- Tariffs raise domestic prices: consumers lose more than producers and government gain, leaving a deadweight loss.
- Quotas and VERs mirror tariffs, but the rent goes to licence holders or foreign exporters.
- Integration ladder: FTA, customs union, common market, economic union, monetary union.
- Blocs help when trade creation exceeds trade diversion.
- Current account deficits are financed by financial account surpluses; CA = (S_p - I) + (T - G).
- IMF = monetary stability and BOP lending; World Bank = development; WTO = trade rules and disputes.
This free module has 5 lessons, 13 practice questions with full explanations.