International Trade and Globalization: Trade Theories (Basics), Balance of Payments and Exchange Rates (Overview) Questions

Question 1

Define international trade.

Accepted Answer

**International trade** is the exchange of goods and services between two or more countries through **imports and exports**.

Question 2

What is comparative advantage?

Accepted Answer

**Comparative advantage** means a country can produce a good at a **lower opportunity cost** compared to another country.

Question 3

Define balance of payments (BOP).

Accepted Answer

**Balance of Payments (BOP)** is a systematic record of all economic transactions between residents of a country and the rest of the world during a given period.

Question 4

What is an exchange rate?

Accepted Answer

**Exchange rate** is the price of one currency expressed in terms of another currency (e.g., Rs per $).

Question 5

What is a tariff?

Accepted Answer

A **tariff** is a tax imposed on **imports**, which increases the price of imported goods.

Question 6

State one benefit of international trade.

Accepted Answer

One benefit of international trade is **specialization**, which improves efficiency and allows countries to gain from trade.

Question 7

Explain absolute advantage and comparative advantage (any three points) with a small table.

Accepted Answer

### **Absolute vs Comparative Advantage**

- **Absolute advantage**: a country can produce a good at **lower absolute cost** or with fewer resources.
- **Comparative advantage**: a country can produce a good at **lower opportunity cost** (relative efficiency).
- Trade can be beneficial even if one country is better at everything, because specialization can be based on **comparative advantage**.

Mini table:

| Concept | Basis | Key word |
|---|---|---|
| Absolute advantage | absolute cost/productivity | **lower cost** |
| Comparative advantage | opportunity cost | **lower opportunity cost** |

Thus, comparative advantage explains why trade benefits both countries through specialization.

Question 8

Explain trade barriers: tariffs and non-tariff barriers (any three points).

Accepted Answer

Trade barriers restrict international trade to protect domestic industry or manage foreign exchange.

- **Tariffs**: taxes on imports; they raise import prices and reduce import quantity.
- **Quotas** (NTB): direct limits on import quantity.
- Other **non-tariff barriers**: licensing, technical standards, subsidies to domestic firms.

Hence, trade barriers protect domestic producers but can increase consumer prices and reduce competition.

Question 9

Explain terms of trade (TOT) and its importance (any three points).

Accepted Answer

### **Terms of Trade (TOT)**

**Terms of trade** show the relationship between export prices and import prices, indicating how many imports a country can buy with a given amount of exports.

Importance (any three):
- **Improved TOT** means the country can import more for the same exports, improving welfare.
- TOT affects **foreign exchange earnings** and the ability to finance imports (oil, machinery).
- TOT influences **trade policy** and long-term competitiveness; unfavorable TOT may pressure currency and BOP.

Thus, TOT is an important indicator of a country's trade position and purchasing power in world markets.

Question 10

Explain balance of payments: current account and capital/financial account (any three points).

Accepted Answer

### **Balance of Payments (BOP) Accounts**

- **Current account** includes trade in **goods** (exports/imports), **services** (tourism, software), **income** (interest/dividend) and **transfers** (remittances).
- **Capital/financial account** includes **FDI/FPI**, loans, banking capital flows and other investment.
- If the current account shows a deficit, it must be financed by **capital inflows** or by using foreign exchange reserves.

Thus, BOP shows how a country earns and spends foreign exchange through current and capital transactions.

Question 11

Explain fixed exchange rate and flexible exchange rate (any three points) with a small comparison table.

Accepted Answer

Fixed vs Flexible exchange rate:

- **Fixed exchange rate**: government/central bank maintains a **fixed parity** (or within a band); requires intervention and reserves.
- **Flexible (floating) exchange rate**: rate is determined by **demand and supply** of foreign exchange in the market.
- Fixed rates provide stability but may be hard to sustain; flexible rates adjust automatically but can be volatile.

Mini table:

| Basis | Fixed | Flexible |
|---|---|---|
| Determination | official parity | market forces |
| Intervention | high | low/occasional |
| Stability | higher | can be volatile |

Thus, countries choose systems based on stability needs and reserve capacity.

Question 12

Explain factors affecting exchange rates (any four) with brief explanation.

Accepted Answer

Factors affecting exchange rates (any four):

- **Inflation differential**: higher domestic inflation reduces competitiveness and tends to **depreciate** currency.
- **Interest rates**: higher interest can attract capital inflows and **appreciate** currency (other things equal).
- **Trade balance**: higher exports increase demand for domestic currency; high imports increase demand for foreign currency.
- **Capital flows (FDI/FPI)**: inflows strengthen currency; outflows weaken it.
- **Expectations/speculation** and political stability also influence currency value.

Hence, exchange rate is influenced by both trade and financial factors.

Question 13

Explain globalization: meaning, advantages and disadvantages (exam-style with table).

Accepted Answer

### **Globalization (Exam-Style)**

**Meaning:** Globalization is the process of increasing integration of economies through **trade**, **investment**, **technology**, and **information flows**.

#### **Advantages**
- **larger markets** and export opportunities for firms
- access to **technology** and foreign capital
- competition improves **efficiency** and quality
- global supply chains can lower cost

#### **Disadvantages**
- small domestic firms may face strong foreign competition
- economy becomes exposed to global shocks (financial crises, supply disruptions)
- inequality can rise if gains are uneven
- exchange rate volatility increases risk for exporters/importers

Table:

| Aspect | Advantages | Disadvantages |
|---|---|---|
| For business | bigger markets, tech access | intense competition, volatility |
| For economy | efficiency, growth potential | vulnerability, inequality |

**Conclusion:** Globalization brings opportunities, but firms and governments must manage risks through competitiveness and stable policy.

Question 14

Explain BOP disequilibrium: causes and remedies (exam-style with flowchart).

Accepted Answer

### **BOP Disequilibrium (Exam-Style)**

**Meaning:** BOP disequilibrium means a persistent **deficit** or **surplus** in a country's balance of payments.

#### **Causes of BOP deficit (common)**
- imports higher than exports due to low export competitiveness
- high import dependence (oil, machinery)
- higher domestic inflation than trading partners
- global slowdown reducing export demand
- capital outflows due to low investor confidence

#### **Remedies/measures**
- **export promotion**: improve quality, reduce cost, diversify markets
- **import management**: encourage import substitution; rational import control
- **exchange rate adjustment**: controlled depreciation to support exports (with caution)
- reduce inflation and improve productivity
- attract stable inflows like **FDI**

Flowchart:

```text
BOP deficit → identify cause (exports↓ / imports↑ / capital outflow)
→ export promotion + productivity improvement
→ manage imports + diversify energy/raw materials
→ adjust exchange rate (if needed) + attract stable capital inflows
→ BOP improves
```

**Conclusion:** Sustainable correction requires improving competitiveness along with careful policy support.

Question 15

Explain how exchange rate changes affect business (exporters, importers, and firms with foreign loans) with a table.

Accepted Answer

### **Exchange Rate Changes and Business Impact**

Exchange rate movements affect revenue, cost, and risk exposure of firms.

Assume domestic currency **depreciates**:
- exporters become more competitive abroad
- import costs rise

Table (simple):

| Business type | Effect of depreciation | Example impact |
|---|---|---|
| **Exporter** | export competitiveness ↑ | foreign buyers find goods cheaper → orders ↑ |
| **Importer / input-heavy firm** | input cost ↑ | imported raw material becomes costly → margin ↓ |
| **Foreign loan borrower** | repayment burden ↑ | same $ loan needs more domestic currency to repay |
| **Domestic competitor vs imports** | gains protection | imported finished goods become costlier |

**Conclusion:** Firms use hedging, pricing revision, and diversification to manage exchange rate risk.

Concept	Basis	Key word
Absolute advantage	absolute cost/productivity	lower cost
Comparative advantage	opportunity cost	lower opportunity cost

International Trade and Globalization: Trade Theories (Basics), Balance of Payments and Exchange Rates (Overview)

Absolute vs Comparative Advantage

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