International Trade and Finance — full notes

International Trade and Finance

1. Basis and gains from trade

Absolute advantage - producing a good using fewer resources than another country. Comparative advantage - a lower opportunity cost of producing a good than another country.

Worked example: Country A: 1 hour produces 10 cloth or 5 wheat. Country B: 1 hour produces 6 cloth or 2 wheat. Opportunity cost of cloth: A=5/10=0.5, B=2/6=0.33. B has comparative advantage in cloth. Opportunity cost of wheat: A=10/5=2.0, B=6/2=3.0. A has comparative advantage in wheat. Both gain by specialising and trading.

2. Terms of trade

The ratio of export prices to import prices.