International trade, exchange rates and the balance of payments

ZIMSEC A Level · Economics · Form 6

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Theory of trade

Absolute advantage: producing more with the same resources.
Comparative advantage: lower opportunity cost. Countries gain by specialising in goods with a comparative advantage and trading.

Worked example: Country A can make 10 tonnes of maize or 5 tonnes of cotton; Country B can make 6 maize or 4 cotton. Who has the comparative advantage in each?

Show answers

opportunity cost of 1 cotton = 2 maize; B: 1 cotton = 1.5 maize → B has comparative advantage in cotton
1 maize = 0.5 cotton; B: 1 maize = 0.67 cotton → A has comparative advantage in maize

Protectionism

Tariffs, quotas, subsidies to domestic producers, and embargoes. Arguments for: infant industries, jobs, strategic industries, anti-dumping. Arguments against: higher prices, retaliation, inefficiency.

The balance of payments

Current account: trade in goods and services, primary income and secondary income (remittances – very important to Zimbabwe's economy).
Capital and financial accounts: investment flows.
A current account deficit can be corrected by expenditure-switching (devaluation, tariffs) or expenditure-reducing policies.

Exchange rates

Floating rates are set by supply and demand for the currency; fixed rates by the government; managed floats combine both.
Depreciation makes exports cheaper and imports dearer; the Marshall–Lerner condition says this improves the trade balance if the sum of export and import price elasticities exceeds one.

Regional integration

Free trade areas (SADC, COMESA, AfCFTA), customs unions and common markets: trade creation versus trade diversion.

Exam tip: Always calculate opportunity costs for both goods in comparative advantage questions.

Check yourself

Give two arguments for protectionism.
Where are diaspora remittances recorded in the balance of payments?
How does a depreciation of the currency affect exports?