CA Foundation · Business Economics

International Trade: formula sheet

Full chapter guide

Key formulas

Absolute advantage rule: Country has absolute advantage in a good if its input per unit (or cost per unit) is lower, or its output per input is higher; Compare the same good across two countries.
Opportunity cost of good X (in terms of Y): Input data (hours per unit): Opportunity cost of 1 X = hours per unit of X ÷ hours per unit of Y. Output data (units per hour): Opportunity cost of 1 X = output of Y ÷ output of X; The two forms are opposite ratios, so check whether the table gives input per unit or output per unit before dividing.
Comparative advantage rule: Country with the lower opportunity cost of a good has the comparative advantage in that good; Opportunity costs of the two goods in one country are reciprocals of each other.
Heckscher-Ohlin rule: Export goods using the abundant factor intensively; import goods using the scarce factor intensively; Based on factor endowments, not on labour productivity differences.
Net barter (commodity) terms of trade: NBTT = (Px ÷ Pm) × 100; Px = export price index, Pm = import price index, same base year. Above 100 means improvement from the base year.
Gross barter terms of trade: GBTT = (Qm ÷ Qx) × 100; Qm = import quantity index, Qx = export quantity index. Compares volumes, not prices.
Income terms of trade: ITT = (Px ÷ Pm) × Qx; With indices, ITT = NBTT × Qx ÷ 100. Shows the capacity to import from export earnings.
Single factoral terms of trade: SFTT = (Px ÷ Pm) × Zx; Zx = export productivity index. Adjusts NBTT for productivity in export industries.
Double factoral terms of trade: DFTT = (Px ÷ Pm) × (Zx ÷ Zm); Zm = productivity index of import-producing industries abroad.
Limits of mutually beneficial terms: Lower domestic opportunity cost of a good < terms of trade < higher domestic opportunity cost of the same good; The terms of trade must lie strictly between the two countries' domestic opportunity costs of the same good. The exporter, who has the lower cost, gets more than its own cost and pays less than the partner's cost. Measure both costs for the same good in the same units.
Domestic price with a specific tariff: Domestic price = World price + Tariff per unit; Applies when the country is a small importer and the tariff is fully passed on to the domestic price.
Domestic price with an ad valorem tariff: Domestic price = World price × (1 + t), where t is the tariff rate as a decimal; A 20% tariff means t = 0.20, so the multiplier is 1.20.
Compound tariff: Total duty per unit = Specific duty + (Ad valorem rate × Value); Add both parts to get the duty on one unit.
Imports: Imports = Domestic demand − Domestic supply (at the prevailing price); Use the quantities at the post-tariff price to get post-tariff imports.
Tariff revenue: Revenue = Tariff per unit × Quantity imported after the tariff; Use post-tariff imports, not pre-tariff imports.
Deadweight loss (linear curves): DWL = ½ × Tariff × (Increase in domestic output) + ½ × Tariff × (Fall in domestic consumption); These are the two triangles. Tariff revenue is the rectangle between them and is not part of the loss.
Import quota: Imports ≤ quota limit; domestic price > world price; Quantity is fixed by the government. Price adjusts upward because supply is restricted.
Export subsidy effect: Effective export price = Normal price − Subsidy per unit; Exporters can sell cheaper abroad, so exports rise. Government spends more.
Dumping: Export price < home price (or < cost of production); This is price discrimination across countries. Anti-dumping duty is meant to offset the gap.
Tariff vs quota: Tariff fixes price (quantity adjusts); quota fixes quantity (price adjusts); Tariff gives revenue to government. Quota gives licence holders the gain unless licences are auctioned.
Preferential trade area: Lower tariffs among members (not zero necessarily); Shallowest form of integration. Members still keep their own tariffs on outsiders.
Free trade area: No internal tariffs + each member sets its own external tariff; Key word: independent tariffs against non-members.
Customs union: Free trade area + common external tariff; This is the difference from a free trade area.
Common market: Customs union + free movement of labour and capital; Factors of production move freely, not only goods.
Economic union: Common market + coordinated economic policies (may include a common currency); Deepest form of integration in the ladder.
WTO functions: Administer agreements + negotiation forum + dispute settlement + trade policy review + capacity building; Remember it as five verbs: administer, negotiate, settle, review, assist.
Balance of trade: BOT = Value of exports of goods − Value of imports of goods; Only visible items. Positive is surplus, negative is deficit.
Current account balance: CAB = Trade balance (goods) + Net services + Net primary income + Net secondary income; Net means receipts minus payments.
Overall BOP: Overall balance = Current account balance + Capital and financial account balance (before reserve changes); Reserve changes are the accommodating item. An overall deficit is financed by drawing down reserves or by borrowing.
Accounting identity: Total credits = Total debits (including accommodating items such as reserve changes, and errors); BOP always balances in accounting terms once accommodating items are included. Disequilibrium refers to autonomous items.
Equilibrium exchange rate: Demand for foreign currency = Supply of foreign currency; Flexible-rate system.
Rupee depreciation: Rupee depreciates when more rupees are needed per unit of foreign currency (e.g. ₹80 per $ to ₹84 per $); A higher rupee price of the dollar means a weaker rupee.

Quick revision

Absolute advantage: a country produces a good using fewer resources than another country.
Comparative advantage: a country produces a good at a lower opportunity cost. Trade can gain even without absolute advantage.
Heckscher-Ohlin idea: countries export goods that use their abundant factors intensively.
Terms of trade = export price index ÷ import price index × 100. A rise means each export buys more imports.
A tariff is a tax on imports. It raises domestic price, protects domestic producers and earns the government revenue.
A quota is a limit on the quantity of imports. It raises domestic price but gives the government no tariff revenue.
A subsidy to domestic producers lowers their cost and helps them compete against imports.
Protection arguments include infant industry, national security and employment. Free trade arguments stress efficiency and consumer choice.
Regional trade blocs give members preferential treatment, which can include lower or zero tariffs among themselves.
The balance of payments records all economic transactions between residents and the rest of the world over a period.
Current account covers goods, services, income and transfers. Capital account covers capital flows.
Under a flexible exchange rate system, demand and supply of currency set the rate. Depreciation makes imports costlier and exports cheaper.

Common mistakes

Confusing absolute and comparative advantage. Fix: Absolute advantage compares resource use per unit. Comparative advantage compares opportunity cost. Always compute the opportunity cost before concluding.
Thinking a country with absolute advantage in both goods should not trade. Fix: Trade still gains if opportunity costs differ. The efficient country specialises where its edge is relatively larger.
Putting import price index in the numerator of NBTT. Fix: Remember: price ratio is export over import. Quantity ratio (gross) is import over export.
Treating a higher NBTT as always better for welfare. Fix: Say 'usually favourable'. Use income terms of trade when volume changes matter.
Calculating revenue on pre-tariff imports. Fix: Always recompute imports at the post-tariff price. Revenue = tariff × post-tariff imports.
Treating a 20% ad valorem tariff as ₹20 per unit. Fix: Ad valorem means a percentage of value. Multiply the price by the rate to get the rupee duty.
Saying a quota gives the government tariff-like revenue. Fix: Remember that a tariff is a tax and earns revenue. A quota is a quantity limit, and the price gain goes to licence holders unless licences are auctioned.
Thinking an export subsidy raises the price paid by foreign buyers. Fix: A subsidy reduces the producer's cost, so the export price falls and exports rise.
Saying the infant industry argument supports permanent protection. Fix: Link infant industry with 'temporary' and 'until it can compete'. Permanent shelter is a criticism, not the argument.
Treating dumping as a free trade argument. Fix: Dumping is a reason some countries give for protection, since cheap foreign goods can harm domestic producers.

Exam tips

Read whether the table gives hours per unit or units per hour before computing any ratio.
If a question mentions 'opportunity cost', the answer is almost always Ricardo's comparative advantage.
Remember that a country can have absolute advantage in both goods but comparative advantage in only one.
For Heckscher-Ohlin MCQs, identify the abundant factor first, then the matching good.
With 0.25 negative marking, skip a numerical only if the data is confusing. The cross-ratio check is usually quick.
Learn the NBTT formula exactly. Most numerical questions are a one-line division.
Memorise the list of terms of trade types with one-line definitions. Match-the-following questions are common.
For comparative advantage, compute opportunity cost per unit of one good only. It saves time.