Library/CFA (Chartered Financial Analyst)/ECONOMICS: CFA® Program Curriculum 2026 • LEVEL I • VOLUME 2/Learning Module 6 International Trade

Learning Module 6 International Trade

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Gains from Trade and Theoretical Foundations5 min

This chapter introduces the economic rationale for international trade and the policy instruments that affect trade flows and welfare. Fundamental gains from trade arise because nations specialize where they hold comparative advantage, enabling higher output, lower average costs (economies of scale), more product variety, and increased competition that improves efficiency. Traditional trade models (Ricardian and Heckscher-Ohlin) explain gains from technological differences and factor endowments, while newer models emphasize scale economies and intra-industry trade under monopolistic competition. Although aggregate welfare tends to rise with freer trade, benefits and costs are unevenly distributed: import-competing workers and firms can lose and may require reallocation or retraining.

Key Points

Comparative advantage and specialization generate trade gains.
Economies of scale and product differentiation explain intra-industry trade.
Aggregate welfare can increase while some stakeholders lose; compensation/adjustment matters.

Trade Restrictions: Tariffs, Quotas, VERs, and Subsidies6 min

Trade restrictions—tariffs, quotas, voluntary export restraints (VERs), export subsidies, and domestic content rules—are tools governments use to protect domestic producers, support employment, raise revenue, or pursue strategic objectives. Tariffs raise domestic prices, increase producer surplus, generate government revenue, and create deadweight loss equal to the sum of lost consumption and inefficient domestic production. Quotas limit import quantities and create quota rents that may accrue to foreign exporters, domestic importers, or the government (if licenses are auctioned); welfare loss under quotas can exceed that under equivalent tariffs if rents accrue to foreigners. VERs are export-side quantity limits imposed by exporters, typically shifting quota rents abroad. Export subsidies encourage exports by paying firms per unit exported but distort production away from comparative advantage and reduce national welfare; in large-country cases, subsidies can depress world prices and partially transfer subsidy cost to foreign consumers. The chapter provides numerical examples for computing tariff impacts (changes in consumer surplus, producer surplus, government revenue, and deadweight loss) and comparative illustrations of quota versus tariff effects.

Key Points

Tariffs produce government revenue but create deadweight losses B + D.
Quotas create quota rents; welfare effects depend on who captures the rents.
Export subsidies distort production and reduce national welfare; countervailing duties can respond.

Regional Integration and Trade Creation vs Trade Diversion5 min

Regional trading arrangements are described at increasing levels of integration: free trade areas eliminate internal tariffs but retain individual external policies; customs unions add common external tariffs; common markets allow free movement of factors of production; economic unions add coordinated economic institutions and possibly common currency. Integration can produce trade creation (low-cost member imports replacing high-cost domestic production) and trade diversion (member imports displacing lower-cost non-member suppliers), with net welfare depending on whether creation exceeds diversion. Advantages of blocs include larger markets, scale economies, technology spillovers, and political cooperation; costs include adjustment burdens on displaced workers, potential loss of policy autonomy, and contagion risk when members face common shocks (as seen in EMU sovereign stress).

Key Points

FTA vs customs union vs common market vs economic union: increasing depth of integration.
Trade creation increases welfare; trade diversion can reduce it—net effect matters.
Deeper integration involves trade-offs between market gains and policy sovereignty.

Investment and Policy Implications5 min

From an investment perspective, trade policy and regional integration materially affect firm revenues, costs, supply chains, and capital flows. Changes in tariffs, quotas, or subsidy regimes alter input costs and market access; uncertainty from potential policy changes raises discount rates for exposed firms or countries. Investors should monitor likelihood, velocity, and impact of trade-policy events and incorporate scenario analysis and signposts into portfolio decision making. Capital flows respond to trade-driven shifts in expected returns; countries with stable, open trade regimes typically attract more capital while those with protection or high geopolitical risk may face capital discounts. Finally, the chapter emphasizes that the overall welfare gains from trade do not imply that every stakeholder benefits—policy choices often balance aggregate gains against distributional consequences, and compensation or adjustment policies are necessary to address losers from trade.

Key Points

Trade policy changes affect firm profitability, supply chains, and valuation (discount rates).
Scenario analysis and signposts help investors prepare for policy shifts.
Open trade regimes tend to attract capital; protection can reduce long-term attractiveness to investors.

Questions

Question 1

Which of the following is a primary reason countries gain from international trade according to comparative advantage theory?

Learning Module 6 International Trade

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