International Trade and Finance
FoundationComparative advantage shows that specialising by opportunity cost and trading benefits all sides; tariffs and quotas raise prices and shrink trade; the balance of payments splits into the current account and the capital and financial account; Hong Kong's Linked Exchange Rate System keeps the Hong Kong dollar between 7.75 and 7.85 per US dollar.
- Comparative advantage is about opportunity cost: even without absolute advantages, specialising and trading benefits everyone
- Hong Kong lives its comparative advantage through re-exports and services exports — trade is vital to the economy
- Tariffs and quotas both raise domestic prices and cut imports; tariffs yield revenue, quota price gaps go to holders
文體小知識：經濟現象說明文——解釋比較優勢與貿易獲益，分析關稅配額等貿易障礙，並介紹國際收支與香港聯繫匯率。
§Text Passage
1The theoretical basis of trade lies in comparing advantages. Absolute advantage looks at using fewer resources or producing more of the same good; comparative advantage looks at opportunity cost — whoever gives up less of other goods to produce something has the comparative advantage in it. By specialising according to comparative advantage and trading, all sides can consume more than under self-sufficiency: the gains from trade.
2Hong Kong's trade pattern embodies comparative advantage. With costly land and labour, manufacturing largely moved north from the 1980s; leveraging its institutions, logistics network and global connections, Hong Kong became a trade, logistics, financial and professional services centre, with re-exports and services exports playing major roles — trade is vital to the economy.
3Trade barriers include tariffs and quotas. A tariff raises the domestic price of imports, reduces consumption, expands domestic production of similar goods and brings the government tax revenue. A quota directly caps import quantities; prices rise just the same, but the government collects no revenue — the price gap goes to quota holders. Hong Kong is a free port that generally levies no tariffs, yet it faces barriers erected abroad.
4Hong Kong overcomes trade barriers through trade promotion, free trade agreements and participation in the World Trade Organization, pressing for open markets. The exchange rate is the price of one currency in another, affecting import and export prices; the balance of payments records the current account (goods, services, income and current transfers) and the capital and financial account; and Hong Kong has run the Linked Exchange Rate System since 1983.
1Summary 重點摘要
Comparative advantage shows that specialising by opportunity cost and trading benefits all sides; tariffs and quotas raise prices and shrink trade; the balance of payments splits into the current account and the capital and financial account; Hong Kong's Linked Exchange Rate System keeps the Hong Kong dollar between 7.75 and 7.85 per US dollar.
2Vocabulary cards Vocabulary
An absolute advantage exists when one can produce the same good with fewer resources or with higher output.
A comparative advantage exists when one's opportunity cost of producing a good is lower than others'; it is the basis for specialisation and trade.
The extra consumption all parties enjoy after specialising by comparative advantage and trading, compared with self-sufficiency.
A tax on imports that raises domestic prices, cuts import volume and yields government revenue.
A barrier capping import quantities; prices rise but the government collects no revenue — the price gap accrues to quota holders.
The statement recording an economy's transactions with the rest of the world, split into the current account and the capital and financial account.
The part of the balance of payments recording goods, services, income and current transfers.
The part of the balance of payments recording flows of investment funds.
The price of one currency in terms of another; its changes affect import and export prices.
Hong Kong's exchange rate regime since 1983, pegging the Hong Kong dollar to the US dollar around 7.8, with convertibility undertakings keeping the market rate within 7.75–7.85.
3Step by step Steps
- Step 1: Absolute and comparative advantageAbsolute advantage compares resource use or output for the same good; comparative advantage compares opportunity cost — whoever gives up less to produce a good has the comparative advantage in it. Specialisation follows comparative advantage, not absolute advantage: even if one side is absolutely better at everything, as long as opportunity costs differ, both gain from trade. For example, a famous doctor writes notes twice as fast as a secretary, yet an hour of consultation is worth far more than typing — hiring a secretary is comparative advantage at work.
- Step 2: Judging comparative advantage with numbersThree steps: list each region's output per unit of resource; compute each good's opportunity cost (how much of the other good is given up); the lower-cost producer specialises in that good, and both gain if the exchange ratio lies between the two opportunity costs. For example, if a unit of cloth costs Country A 2 units of rice and Country B 3 units, A has the comparative advantage in cloth; a ratio of 1 cloth to between 2 and 3 rice, say 1 to 2.5, benefits both.
- Step 3: Hong Kong's trade pattern and the importance of tradeWith high land and labour costs, Hong Kong's manufacturing largely moved north from the 1980s. Leveraging its institutions, rule of law, information and logistics network, Hong Kong became a trade, logistics, financial and professional services hub: most goods trade is re-exports, and services exports matter greatly. Total goods and services trade far exceeds GDP. For example, mainland-made electronics are re-exported worldwide through Hong Kong, which earns freight, insurance, financing and trade-service income.
- Step 4: Types of trade barriers and the effects of a tariffBarriers include tariffs (taxes on imports), quotas (quantity limits), embargoes, subsidies and technical or administrative standards. For a small open economy, a per-unit tariff raises the domestic price of imports, reduces consumption, raises domestic production of similar goods, reduces import volume and brings the government revenue. For example, with world rice at 10 dollars a kilogram, a 2-dollar tariff lifts the domestic price to 12: consumers pay more and eat less, local rice growers expand, and the government taxes the remaining imports.
- Step 5: Quotas and other barriersA quota directly caps import quantities; the domestic price rises and local production expands just as with a tariff, but the government collects no revenue — the gap between the world and domestic prices accrues to importers holding quotas; auctioning quotas could recapture part of it. Embargoes are the harshest barrier, banning certain goods outright; administrative and technical standards raise foreign goods' entry costs in the name of safety or hygiene. For example, textile quotas once raised clothing prices, with quota holders pocketing the gap while consumers bore the burden.
- Step 6: How Hong Kong overcomes trade barriersHong Kong has three approaches. Trade promotion: the Trade Development Council and government departments help firms open markets and meet buyers. Bilateral and regional arrangements: free trade agreements such as the Mainland and Hong Kong Closer Economic Partnership Arrangement let qualifying Hong Kong goods enter the Mainland at zero tariff. The multilateral system: as a founding WTO member, Hong Kong relies on multilateral rules to seek openness and settle disputes. For example, Hong Kong-made jewellery and watches enter the Mainland tariff-free with certificates of origin.
- Step 7: Exchange rates, the balance of payments and the Linked Exchange Rate SystemThe exchange rate is the price of one currency in another: a stronger Hong Kong dollar raises export prices in foreign currency and lowers import prices in local currency. The balance of payments has two main parts: the current account records goods, services, income and current transfers; the capital and financial account records investment flows. Since 1983 Hong Kong has run the Linked Exchange Rate System, pegging the Hong Kong dollar to the US dollar around 7.8, with convertibility undertakings keeping the market rate within 7.75 to 7.85. For example, when the US dollar strengthens, the Hong Kong dollar follows, making exports dearer abroad, so firms must rely on efficiency and branding to stay competitive.
4Diagrams Diagrams
5Worked example Example
Application practice: a small open economy produces no cars and imports all of them. The world market price is 100,000 dollars per car; the government then imposes a per-unit tariff of 20,000 dollars on each imported car. Explain the tariff's effects on the domestic price, consumers, domestic producers of similar cars and government revenue. If an import quota with the same effect is used instead, how do these effects differ?
- Price and consumers: the tariff raises the domestic price from 100,000 to 120,000 dollars; consumers pay more and buy less — they bear the heaviest burden
- Domestic producers: prices of similar cars rise too, so local producers expand output and revenue, hence their support for the tariff
- Government revenue: the government collects 20,000 dollars on each of the remaining imports, earning tariff revenue; import volume falls as prices rise
- Quota comparison: a quota raises the price to 120,000 dollars with the same import volume, leaving consumers and producers unaffected in relative terms — but the government collects nothing, and the 20,000-dollar-per-car gap goes to quota holders
- Answer: With the 20,000-dollar per-unit tariff, the domestic price rises to 120,000 dollars a car: consumers pay more and buy less; domestic producers of similar cars expand output and revenue; and the government earns 20,000 dollars on each of the remaining imports. Under an equivalent quota, the price, consumption and production effects are identical, but the government earns no revenue — the price gap goes to quota holders.
6Common mistakes Mistakes
7Quick check Quick check
Q1What distinguishes comparative advantage from absolute advantage?
Q2Producing 1 unit of cloth costs Country A 2 units of rice and Country B 3 units. Who has the comparative advantage in cloth, and what are mutually beneficial terms of trade?
Q3How does a tariff affect the domestic price of imports, import volume and government revenue?
Q4What are the four main components of the current account?
Q5What exchange rate system does Hong Kong run, and what is the convertibility range?
8Recap Recap
- Comparative advantage is about opportunity cost: even without absolute advantages, specialising and trading benefits everyone
- Hong Kong lives its comparative advantage through re-exports and services exports — trade is vital to the economy
- Tariffs and quotas both raise domestic prices and cut imports; tariffs yield revenue, quota price gaps go to holders
- Hong Kong overcomes barriers via trade promotion, free trade agreements and the WTO's multilateral system
- The balance of payments splits into the current account and the capital and financial account; the LERS pegs HK$ around 7.8, within 7.75–7.85