The video lesson for this unit is recorded and waiting to be published. Until it is, the
rules and the method below carry everything this session needs; watching is a way of hearing it, not the only
way of getting it.
The reading
No written reading for this unit yet. The rules and the method below,
and the practice questions, still carry everything this session needs.
What this unit turns on
Read these before the questions, not after them. Everything here traces to this
module's own lesson and to the 2026 outline.
No written rules are authored for this module yet. The questions below still carry a full explanation on every choice, and the next authoring lane closes this gap.
The practice run
Pick an answer, say how sure you are, then reveal. Being sure and wrong is the most
useful thing that can happen in a session, so answer honestly: it sends the unit back to learning and puts it
at the front of your revision queue.
Question 1Exam level
A country runs a current account deficit of $50 billion. Which of the following must most likely be true?
How sure are you?
Correct: B. The BOP identity requires: Current Account + Capital Account + Financial Account = 0. A $50B current account deficit must be offset by a ~$50B combined surplus in the capital and financial accounts (capital account is typically very small, so the financial account carries most of the offset). Option A is wrong. Twin deficits (fiscal + current account) are correlated but not required. Option C is wrong. A deficit can persist for years with a stable or appreciating currency if capital inflows are strong (e.g., US dollar 1990s).
A. Option A is wrong. Twin deficits (fiscal + current account) are correlated but not required.
C. Option C is wrong. A deficit can persist for years with a stable or appreciating currency if capital inflows are strong (e.
Unit: international-trade
Question 2Exam level
Which of the following transactions would most likely be recorded in the CURRENT account of the United States balance of payments?
How sure are you?
Correct: B. Dividends received from a foreign subsidiary are income flows. They belong in the current account under 'primary income' (investment income). Option A (purchase of foreign shares) is a financial account transaction. It is an outflow of capital representing a financial investment. Option C (foreign purchase of US Treasuries) is also a financial account transaction. An inflow of foreign capital.
A. Option A (purchase of foreign shares) is a financial account transaction. It is an outflow of capital representing a financial investment.
C. Option C (foreign purchase of US Treasuries) is also a financial account transaction. An inflow of foreign capital.
Unit: international-trade
Question 3Exam level
Country X imposes a tariff on imported steel. Which of the following best describes the effect on Country X's economy?
How sure are you?
Correct: B. A tariff raises the domestic price above the world price. Domestic consumers pay more, so consumer surplus falls. Domestic producers receive a higher price, so producer surplus rises. The government collects tariff revenue. However, the combined deadweight loss triangles (production inefficiency + consumption inefficiency) exceed the government revenue gain for a small country that cannot affect world prices. Net welfare is negative. For a large country that can depress world prices, the terms-of-trade gain may partially offset the deadweight loss. But even then the global welfare effect is negative.
A. You might be thinking that a tariff benefits consumers by providing more options, but this overlooks the fact that tariffs increase prices, reducing consumer surplus; also, tariffs support domestic producers by raising prices, which increases producer surplus, not decreases it as choice A suggests.
C. You might be tempted by choice C if you assume that tariffs benefit both consumers and producers, but tariffs actually raise domestic prices, reducing consumer surplus, while only the domestic producers who remain in the market benefit, and the overall deadweight loss means net welfare is negative, not positive.
Unit: international-trade
Question 4Exam level
Which of the following is most likely the best argument for imposing trade restrictions according to the CFA curriculum?
How sure are you?
Correct: B. The 'infant industry argument' is the strongest justification for temporary trade protection in the CFA curriculum. The argument is that a new industry may need time to develop scale, technology, and learning-curve advantages before it can compete on world markets. Once mature, protection should be removed. Option A is not a valid argument. Competitive industries do not need protection. Option C is invalid because permanent protection raises prices for consumers and reduces economic efficiency long-term.
A. Option A is not a valid argument. Competitive industries do not need protection.
C. Option C is invalid because permanent protection raises prices for consumers and reduces economic efficiency long-term.
Unit: international-trade
Question 5Exam level
The J-curve effect predicts that immediately following a depreciation of the domestic currency, the trade balance will most likely:
How sure are you?
Correct: B. The J-curve describes the typical path of the trade balance after a currency depreciation. In the short run, import prices rise immediately (imports become more expensive in domestic currency terms) while export and import VOLUMES are slow to adjust because of existing contracts, time to find new suppliers, and consumer behavior inertia. The result is a worsening trade balance initially. Over 6–18 months, volumes adjust. Exports increase (foreigners buy more) and imports decrease (residents buy less). And the trade balance improves. The shape traces a J: initial dip, then recovery.
A. You might be thinking that cheaper exports will immediately boost export sales, but this overlooks the time lag in volume adjustments; prices may drop, but it takes time for foreign buyers to increase their orders, so the trade balance does not improve right away.
C. You might be tempted by choice C if you assume that foreign currency denomination of trade contracts keeps the trade balance steady, but this overlooks the immediate impact of currency depreciation on import costs, which actually causes the trade balance to worsen before improving as export volumes adjust.
Unit: international-trade
Question 6Harder
Country A can produce 10 units of wheat or 5 units of cloth per worker. Country B can produce 6 units of wheat or 4 units of cloth per worker. Which of the following is most accurate?
How sure are you?
Correct: B. Opportunity costs: Country A. 1 unit of wheat costs 0.5 cloth (5/10); 1 unit of cloth costs 2 wheat (10/5). Country B. 1 unit of wheat costs 0.67 cloth (4/6); 1 unit of cloth costs 1.5 wheat (6/4). Country A's opportunity cost of wheat (0.5 cloth) is LOWER than Country B's (0.67 cloth). So Country A has comparative advantage in wheat. Country B's opportunity cost of cloth (1.5 wheat) is LOWER than Country A's (2 wheat). So Country B has comparative advantage in cloth. Country A has absolute advantage in both goods, but comparative advantage still exists and trade is mutually beneficial.
A. You might be tempted by choice A if you confuse absolute advantage with comparative advantage, thinking that having an absolute advantage in both goods precludes any trade benefits. However, comparative advantage, not absolute advantage, determines the basis for mutually beneficial trade, as countries can still benefit from specializing in the production of goods for which they have the lowest opportunity cost.
C. You might be misled by the absolute production numbers, thinking that since Country B produces more cloth relative to wheat, it has a lower opportunity cost for wheat. However, comparative advantage is determined by opportunity costs, not absolute production, and Country B's opportunity cost for wheat (0.67 cloth) is actually higher than Country A's (0.5 cloth), indicating Country A has the comparative advantage in wheat.
Unit: international-trade
Question 7Exam level
Which of the following is most likely to be classified in the CAPITAL account (not the financial account) of the balance of payments under BPM6?
How sure are you?
Correct: B. Under BPM6 (the standard the CFA curriculum follows), the capital account records capital transfers (such as debt forgiveness, migrant transfers, and non-produced, non-financial assets like patents and land). Debt forgiveness is a capital transfer. Options A and C are financial account items. FDI and portfolio investment are both classified in the financial account under BPM6.
A. You might think foreign direct investment inflows belong in the capital account because they involve capital, but under BPM6, FDI inflows are actually classified in the financial account, not the capital account, which is reserved for capital transfers like debt forgiveness.
C. You might be tempted to choose C because purchasing foreign equities seems like it could involve a significant transfer, but under BPM6, the purchase of foreign portfolio equities falls under the financial account, not the capital account, as it represents an investment in financial assets rather than a capital transfer like debt forgiveness.
Unit: international-trade
Question 8Harder
A quota on imported automobiles is most likely to differ from an equivalent tariff (a tariff that reduces imports by the same amount) in that:
How sure are you?
Correct: B. The key difference between a tariff and an equivalent quota is the disposition of the revenue/rent. A tariff raises the domestic price and the government collects tariff revenue (price difference × import quantity). A quota raises the domestic price by the same amount and by the same import quantity. But the 'quota rent' (the economic profit from selling at the elevated domestic price) accrues to whomever holds the import license. If the government auctions licenses, it can capture the rent; if licenses are given to foreign exporters or domestic importers, they capture the rent. The consumer surplus loss is identical in both cases. Option A is incorrect. Consumer surplus impact is the same. Option C is incorrect. By definition, 'equivalent quota' reduces imports by the same amount.
A. Option A is incorrect. Consumer surplus impact is the same.
C. Option C is incorrect. By definition, 'equivalent quota' reduces imports by the same amount.
Unit: international-trade
Question 9Exam level
A persistent current account deficit is MOST consistent with which of the following conditions in the same country?
How sure are you?
Correct: C. The national accounting identity links the current account to savings and investment: CA = (S - I) + (T - G), where S = private savings, I = private investment, T = taxes, G = government spending. Alternatively: CA = National Savings - Domestic Investment. A current account deficit means the country is investing more than it saves domestically. It must import capital (financial account surplus) to fund the gap. The US provides the classic example: persistent current account deficits reflecting investment demand that exceeds domestic savings, funded by capital inflows from surplus countries (China, Germany, Japan).
A. Choosing A might seem logical if you think a surplus in savings would naturally lead to a surplus in the current account, but this overlooks the identity CA = National Savings - Domestic Investment, where a deficit indicates domestic investment is outpacing national savings, not the other way around.
B. You might be tempted by choice B because a fiscal surplus and high private savings suggest strong national savings, but this choice violates the national accounting identity since it implies a current account surplus, not a deficit, as strong savings would finance domestic investment and possibly lead to excess savings being invested abroad.
Unit: international-trade
Question 10Exam level
According to the Heckscher-Ohlin model, a capital-abundant country will most likely export:
How sure are you?
Correct: B. The Heckscher-Ohlin (H-O) model predicts that countries export goods that use their abundant factor of production intensively. A capital-abundant country (e.g., the United States, Germany) has relatively cheap capital, so it has a comparative advantage in producing goods that require a lot of capital (machinery, aircraft, semiconductors). A labor-abundant country (e.g., Bangladesh, Vietnam) has relatively cheap labor, so it exports labor-intensive goods (garments, footwear). This extends Ricardo's comparative advantage model from a single factor (labor) to two factors (labor and capital).
A. Scarcity does not decide what a country exports under the Heckscher-Ohlin model, relative abundance and cost do. A capital-abundant country has labor that is comparatively scarce and therefore expensive, so labor-intensive goods cost more to produce there than in a labor-abundant country. The country's comparative advantage sits with its cheap, abundant factor, which is capital, not with the scarce, expensive one.
C. Choosing an equal mix of capital- and labor-intensive goods might seem like a balanced approach, but it overlooks the H-O model's core principle that countries have a comparative advantage in goods that use their abundant factor intensively, not a balanced mix of goods.
Unit: international-trade
Question 11Harder
An export subsidy granted by a government to domestic producers most likely results in:
How sure are you?
Correct: B. An export subsidy lowers the price of the good for foreign buyers, encouraging domestic producers to export more. To supply the export market, domestic producers divert supply away from the domestic market, raising the domestic price above the world price. Domestic consumers pay more (consumer surplus falls). Domestic producers receive the higher domestic price plus the subsidy (producer surplus rises). The government pays the subsidy (budget cost). The net effect is a welfare loss: government expenditure + consumer surplus loss > producer surplus gain. The world price also falls, harming producers in competing countries while benefiting foreign consumers.
A. You might be thinking that subsidies always lower prices, thus increasing consumer surplus, but an export subsidy actually raises domestic prices by diverting supply to exports, reducing domestic consumer surplus and increasing government expenditure rather than decreasing it.
C. You might be tempted to think that subsidies always benefit both producers and consumers, but in this case, the export subsidy actually raises domestic prices and reduces consumer surplus, violating the concept that subsidies can lead to a net welfare loss due to increased government expenditure and higher domestic prices.
Unit: international-trade
Question 12Exam level
Which of the following best describes the Marshall-Lerner condition?
How sure are you?
Correct: A. The Marshall-Lerner condition states that a currency depreciation will improve the trade balance ONLY IF the sum of the absolute price elasticities of demand for exports and imports is greater than 1 (|e_x| + |e_m| > 1). If elasticities are low (inelastic demand), the volume response will be insufficient to offset the price change, and the trade balance may not improve even after depreciation. The J-curve reflects that in the short run, elasticities are low (close contracts, habit), so the condition is initially not met. But as time passes, elasticities rise and the condition is eventually satisfied, producing the J-curve recovery.
B. You might be tempted by choice B if you associate tariffs with trade balance improvements, but the Marshall-Lerner condition specifically deals with currency depreciation effects on trade balance, not tariff impacts on terms of trade.
C. You might be tempted by choice C because it seems to align with the idea of financial flows balancing trade flows, but the Marshall-Lerner condition specifically deals with the impact of currency depreciation on trade balances through price elasticities, not with the role of foreign direct investment in offsetting deficits.