INTERNATIONAL TRADE

1. International trade matters to investors because trade policy changes the volume and value of trade, which then changes firm demand, pricing power, profitability, and growth. 2.

2. What is international trade: countries buying and selling goods and services across borders instead of producing everything at home. The intuition is simple: you do not make your own phone, shirt, food, and car alone; countries behave the same way.

3. Trade creates gains from exchange because a country can sell exports at a higher price or buy imports at a lower price than domestic production would allow.

4. What is gains from exchange: value created because each side gives up something less useful to receive something more useful. If importing is cheaper than producing at home, resources stop being trapped in the wrong place.

5. Trade also creates specialization because countries shift resources toward goods they produce relatively cheaply and away from goods they produce relatively expensively.

6. What is comparative advantage: lower opportunity cost in producing one good relative to another. The exam trap is that a country can benefit from trade even without absolute advantage.

7. What is absolute advantage: producing more output with the same resources than another country. CFA usually cares more about comparative advantage because trade follows relative cost, not raw superiority.

8. If tea is relatively cheaper in Tealand and copper is relatively cheaper in Copperland, Tealand exports tea, Copperland exports copper, and both industries expand in their own export direction.

9. Trade increases welfare because production shifts toward relatively efficient producers, consumption possibilities expand, and the economy can consume a larger bundle of goods.

10. Do not read “trade increases welfare” as “everyone wins.” It means the total gain is large enough that winners could theoretically compensate losers and still remain better off.

1. Trade creates economies of scale because a firm gets access to a bigger market, produces more units, spreads fixed costs, and lowers average cost.

2. What is economies of scale: average cost falls as output rises. Think of a car factory: once the expensive plant exists, producing more cars can make each car cheaper.

3. Newer trade models focus on economies of scale, product variety, and increased competition, not only old-style specialization from technology or factor endowments.

4. What is intra-industry trade: a country both exports and imports goods in the same product category. Europe exporting and importing different cars is the clean source example.

5. Intra-industry trade exists because consumers like variety and firms can specialize in different versions of the same broad good.

6. What is monopolistic competition: many firms sell differentiated products, entry and exit are open, and long-run economic profit is zero. This structure explains why similar countries still trade varieties.

7. Trade increases competition because foreign firms reduce domestic monopoly power, forcing local firms to become more efficient or lose customers.

8. Trade can raise real gross domestic product because resources are allocated better, firms learn by doing, productivity rises, and knowledge spills across borders.

9. What is learning by doing: production experience lowers future production cost. In semiconductors, the more you produce, the more expertise you build into the process.

10. What is knowledge spillover: one firm’s or country’s research and experience indirectly improves another’s productivity. Trade opens more channels for ideas, technical skill, and consumer preference signals.

1. The cost of trade is adjustment pain: export industries expand, import-competing industries shrink, less-efficient firms exit, and workers may need retraining before the long-run welfare gain becomes visible.

2. Developed markets may face job losses from import competition, and trade can increase income inequality if gains concentrate in expanding firms while displaced workers carry the adjustment cost.

TRADE RESTRICTIONS

1. Trade restrictions are government policies that limit free trade by households and firms across borders.

2. What is trade protection: barriers used to shield domestic industries from foreign competition. The word “protection” sounds friendly, but CFA wants you to track who pays for it.

3. Countries impose trade restrictions to protect established industries, protect infant industries, support employment, protect strategic industries, raise revenue, reduce trade deficits, or retaliate.

4. What is an infant industry argument: the claim that a new domestic industry needs temporary protection until it becomes competitive. The hidden risk is that “temporary” protection can become permanent inefficiency.

5. A tariff is a tax on imported goods, usually meant to protect domestic producers or reduce a trade deficit.

6. How is a tariff done: the government adds a tax per imported unit or as a percentage of import value, raising the domestic import price above the world price.

7. For a small importing country, a tariff raises domestic price, increases domestic production, reduces domestic consumption, and reduces imports.

8. What is a small country: a country that is a price taker in the world market for that product. It cannot move the world price by changing its own import demand.

9. What is a large country: a large importer that can influence the world price. If it imposes a tariff, exporters may lower prices to preserve market share.

10. A large country can theoretically gain from a tariff only if terms-of-trade improvement exceeds deadweight loss and trade partners do not retaliate.

11. What is terms of trade: the price of exports relative to imports. If import prices fall because foreign sellers absorb part of the tariff, the importing country gains at the exporter’s expense.

12. Tariff welfare math is simple: consumers lose, producers gain, government gains revenue, but the consumer loss is larger than producer gain plus government revenue in a small country.

13. What is consumer surplus: value consumers get above what they pay. When price rises after a tariff, buyers lose surplus because some pay more and others stop buying.

14. What is producer surplus: value producers get above their cost. Domestic producers gain after a tariff because they sell more units at a higher price.

15. What is deadweight loss: welfare destroyed because mutually beneficial trades no longer happen or inefficient producers stay active.

16. A tariff creates production inefficiency because higher-cost domestic producers enter or survive even though world producers could supply the good more cheaply.

17. A tariff creates consumption inefficiency because consumers willing to pay more than the world price but less than the tariff-inflated price stop consuming.

18. A quota restricts the quantity of imports allowed during a period.

19. How is a quota done: the government issues import licenses that specify how much of the good can be imported.

20. A quota can mimic a tariff’s price effect, but the key difference is who captures the money created by restricted supply.

21. What is quota rent: extra profit created when import quantity is restricted and price rises. It may go to foreign producers, importers, or the government if licenses are auctioned.

22. If quota rents go to foreign producers, the importing country loses more welfare under a quota than under an equivalent tariff. Why? Tariff = “entry fee” paid to your government. Quota with foreign rents = “entry fee” paid to foreigners. Same price hike, same distortion, but under a tariff your government at least gets the money; under such a quota, that money leaves the country. So your country’s net loss is bigger.

23. If the importing government auctions quota licenses, quota welfare loss can resemble tariff welfare loss because the government captures the rent.

24. A voluntary export restraint is a quota-like barrier where the exporting country agrees to limit exports. Exporting country, not the importing country. Imagine United States begging China not to sell electronics in US and China agrees.

25. Why is voluntary export restraint worse for the importer: quota rent goes to foreign exporters, not the importing government or domestic importers. Why? Because who pockets the “scarcity markup” changes. VER = foreign government/firms agree to ship less. Price in your country rises above world price, exactly like a quota or tariff. The extra price margin is quota rent. Under a VER, foreigners capture this rent.

1. An export subsidy is a government payment to a firm for each exported unit.

2. Why is export subsidy used: the government wants to stimulate exports by making foreign sales more attractive than domestic sales.

3. Export subsidy raises domestic price in the exporting country because firms shift goods away from domestic buyers toward foreign buyers.

4. Export subsidy reduces welfare because it pushes production and trade away from comparative advantage and forces taxpayers to fund the distortion. Why? Government pays firms to push more stuff abroad than is actually efficient. That money comes from taxpayers. At home, prices rise and consumers lose. Abroad, prices fall and foreigners gain. The total gain to producers + foreigners is smaller than the subsidy cost → net welfare loss.

5. Countervailing duties are import duties imposed against subsidized exports entering a country. What is countervailing duty: a defensive tariff against another country’s subsidy. The importing country uses it to offset the artificial price advantage of subsidized foreign goods. Suppose China subsidizes its phone manufacturers and Donald Trump slaps tariffs on phones to countervail that subsidy.

6. Domestic content provisions require part of a product’s value added or components to come from domestic sources. Suppose Donald Trump forces that Apple has to manufacture touchscreens in United States and nowhere else.

7. What is value added: the extra value created at a production stage. Domestic content rules force firms to source some inputs locally even if foreign inputs are cheaper.

8. Trade restrictions affect investment because they can change input costs, product demand, pricing policy, paperwork delays, licenses, and industry structure.

TRADING BLOCS AND REGIONAL INTEGRATION

1. A regional trading bloc is a group of countries agreeing to reduce or remove trade barriers and sometimes allow freer movement of production factors. What are factors of production: inputs used to produce output, mainly labor and capital. If factors move freely, firms can place workers, factories, and financing where they work best.

2. Regional integration is popular because smaller-country coordination is easier, quicker, and less politically contentious than global negotiations through the World Trade Organization.

3. What is the World Trade Organization: a global forum for trade rules and dispute settlement. In this module, it explains why smaller regional agreements became attractive when large negotiations stalled.

4. A free trade area removes trade barriers among members but lets each member keep its own trade policy against non-members. How to recognize free trade area: free trade inside the club, separate external barriers outside the club. The United States-Mexico-Canada Agreement is a good example.

5. A customs union is a free trade area plus a common trade policy against non-members. How to recognize customs union: free internal trade and one shared external tariff wall. If external policy is common, it is already beyond a free trade area.

6. A common market is a customs union plus free movement of factors of production among members. How to recognize common market: goods, services, labor, and capital can move more freely. Firms can locate production and source components wherever comparative advantage is strongest inside the bloc.

7. An economic union is a common market plus common economic institutions and coordinated economic policies. A monetary union is an economic union whose members adopt a common currency.

8. Ranking the integration ladder: free trade area removes internal goods barriers; customs union adds common external policy; common market adds factor mobility; economic union adds policy coordination; monetary union adds common currency.

9. Regional blocs create benefits similar to free trade: specialization, lower monopoly power, scale economies, learning by doing, technology transfer, foreign investment, and better intermediate inputs.

10. Regional blocs can also reduce conflict because members become economically interdependent and gain bargaining power by acting together.

11. Trade creation occurs when regional integration replaces high-cost domestic production with lower-cost imports from member countries. Why trade creation is good: production moves from inefficient domestic producers to more efficient member producers, so resources are used better and welfare tends to rise.

12. Trade diversion occurs when lower-cost imports from non-members are replaced by higher-cost imports from members because non-members still face barriers. Why trade diversion is bad: the bloc makes a member look cheaper only because the true low-cost outsider is taxed or blocked. A good example is Germany selling products in the EU. Germany has a pact with many European countries to sell only German made products and not Chinese products.

13. Net welfare from a regional trade agreement depends on whether trade creation is larger than trade diversion.

14. Regional integration attracts investors because firms can serve larger markets with fewer barriers and lower average costs.

15. The investment trap is that one big bloc is not one identical market; tastes, culture, and competitive conditions can still differ across member countries.

16. Another investment trap is contagion: depending on integration depth and safeguards, problems in one member can spread quickly to other members.