Economics · Lesson 21

International trade, terms of trade & balance of payments

JAMBWAECNECO

What the syllabus asks

JAMB: International trade: meaning, basis (absolute and comparative advantage), terms of trade, balance of trade and balance of payments (meaning, components, disequilibrium and measures of correction); composition and direction of Nigeria’s foreign trade; exchange rate determination and systems; devaluation

WAEC: International trade: meaning; basis – absolute and comparative advantage; advantages and disadvantages; terms of trade and their measurement; balance of trade and balance of payments – structure, disequilibrium and correction; commercial policy instruments (tariffs, quotas, embargoes, subsidies, exchange control); exchange rates – fixed, flexible, managed; devaluation; economic integration

NECO: International trade: meaning; basis – absolute and comparative advantage; advantages and disadvantages; terms of trade and their measurement; balance of trade and balance of payments – structure, disequilibrium and correction; commercial policy instruments (tariffs, quotas, embargoes, subsidies, exchange control); exchange rates – fixed, flexible, managed; devaluation; economic integration

What you will learn

Explain the meaning and basis of international trade, distinguishing absolute and comparative advantage.
Calculate gains from specialisation using opportunity costs.
State the advantages and disadvantages of international trade.
Calculate and interpret the terms of trade.
Describe the structure of the balance of payments and calculate account balances.
Explain causes and correction of BOP disequilibrium, including commercial policy instruments.
Explain exchange rate systems and the effects of devaluation, and describe Nigeria’s foreign trade.

Key points

International trade: exchange of goods and services between countries.
Comparative advantage: specialise where opportunity cost is lowest; trade can benefit both.
Advantages: variety, larger output, economies of scale, forex; disadvantages: dependence, dumping, infant-industry collapse.
TOT = export price index ÷ import price index × 100; above 100 favourable.
BOT = visible exports − visible imports; BOP records all transactions.
Current account: goods, services, income, transfers; capital & financial: investment and loans.
Deficit causes: import dependence, inflation, over-valued currency, falling export prices.
Remedies: expenditure-switching (tariffs, quotas, devaluation) and expenditure-reducing (fiscal, monetary).
Exchange rates: fixed, floating, managed; more ₦ per $ = weaker naira.
Devaluation works if demand for exports and imports is elastic (Marshall–Lerner).
Nigeria: exports dominated by crude oil; imports of machinery, manufactures, food, refined fuel.

Start here: Meaning and reasons for international trade

The phone in your pocket may be assembled in Asia, the rice in a Kano market may be grown in Kebbi or imported, and crude oil from the Niger Delta is shipped to refineries in other continents. This exchange across borders is international trade.

International trade is the exchange of goods and services between residents of different countries. It differs from domestic (internal) trade, which takes place within one country.

Why countries trade

Uneven distribution of natural resources: some countries have oil, others have fertile land or minerals.
Differences in climate: cocoa needs tropical conditions; wheat grows best in temperate zones.
Differences in skills, technology and capital.
Economies of scale: a larger world market lets firms produce at lower cost.
Variety: consumers want goods not produced at home.

How international trade differs from domestic trade

Different currencies must be exchanged.
Different laws, customs regulations and tariffs.
Greater distance and transport costs, and greater risk.
Language and cultural differences.
Factors of production are less mobile between countries than within.

Worked example 21.1

Give the main reason each trade happens: (a) Nigeria imports wheat; (b) a landlocked country imports through Nigerian ports; (c) Nigeria exports crude oil.

(a) Climate: wheat grows less well in most of Nigeria’s climate.
(b) Geography: no sea access (this creates transit trade).
(c) Natural resource endowment.

Climate; geography; resources

⚠️ Common mistake: writing "different currencies" as a reason why countries trade. It is a difference between international and domestic trade, not a cause of trade.

Try it yourself. State two ways international trade differs from home trade.

Show solution

Any two: different currencies, different laws and tariffs, longer distances, greater risk, language differences.

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Practice questions

1. International trade is based mainly on the principle of

comparative advantage
absolute poverty
consumer sovereignty
diminishing returns

Show answer

A: comparative advantage
Specialise where opportunity cost is lowest.

2. Nigeria produces 10 cocoa or 30 cloth; Ghana produces 20 cocoa or 20 cloth. Nigeria should specialise in

cocoa
both
neither
cloth

Show answer

D: cloth
Nigeria's cost of 1 cloth = 1/3 cocoa, lower than Ghana's 1.

3. Terms of trade are calculated as

exports − imports
visible + invisible trade
export price index ÷ import price index × 100
imports ÷ exports

Show answer

C: export price index ÷ import price index × 100
TOT index.

4. Export price index 120, import price index 100. Terms of trade are

20
120 (favourable)
83 (unfavourable)
100

Show answer

B: 120 (favourable)
120 ÷ 100 × 100.

5. The balance of trade records

visible exports and imports
all transactions
capital flows only
services only

Show answer

A: visible exports and imports
Goods only.

Key words

International trade: Exchange of goods and services between countries.
Absolute advantage: Ability of a country to produce more of a good than another with the same resources.
Comparative advantage: Ability to produce a good at a lower opportunity cost than another country.
Terms of trade: Rate at which a country’s exports exchange for its imports, measured by an index ratio.
Visible trade: Trade in physical goods.
Invisible trade: Trade in services, e.g. shipping, insurance, tourism.
Balance of trade: Value of visible exports minus visible imports.
Balance of payments: Systematic record of all economic transactions between residents of a country and the rest of the world over a period.
Current account: Part of the BOP recording goods, services, income and current transfers.
Capital and financial account: Part of the BOP recording investment flows and loans.
BOP disequilibrium: A persistent deficit or surplus in the balance of payments.
Tariff: A tax on imported goods.

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