1. There are two countries and two commodities (2 x 2 model).
2. Labour is the only factor of production.
3. Labour units are homogeneous.
4. The cost or price of a commodity is measured by the amount of labour required to produce it.
5. There is no transport cost.

(i) FOREX refers to foreign currencies.
(ii) It is the mechanism through which payments are effected between two countries having different currency systems.

According to Ricardo a country can gain from trade when it produces at relatively lower costs. Even when a country enjoys absolute advantage in both goods, the country would specialize inthe production and export of those goods which are relatively more advantageous.

(i) The balance between the values of goods and services exchanged between two countries.
(ii) It is a trade in both visible and non visible items.

The rate at which goods of one country are exchanged for that of another country i.e. ratio of export price and import price.

1. Price Adjustments
As a result of foreign exchange outflow from a deficit country to a surplus country, there will be a fall in the money supply in the deficit country and increase in the money supply in the surplus country.
2. Interest Rate Adjustments
The contraction or expansion of money supply resulting from the BoP deficit or surplus leads to a rise or fall in the interest rates. A rise in interest rate in the deficit country will encourage investors to withdraw their funds from abroad and invest in their home country.
3. Income Adjustments
A nation with payments surplus will experience rising income which will increase imports and thereafter equilibrium is restored in Balance of Payments.
4. Capital Flows
Changes in the interest rate consequent to the BoP disequilibrium will encourage capital flows from the surplus nations to deficit nations helping restoration of the BoP equilibrium.

1. There are two countries, two commodities and two factors. (2 x 2 x 2 model).
2. Countries differ in factor endowments.
3. Commodities are categorized in terms of factor intensity.
4. Countries use same production technology.
5. Countries have identical demand conditions.
6. There is perfect competition in both product and factor markets in both the countries.

(i) Factor endowment of a country may change over time.
(ii) The efficiency of the same factor may differ in the two countries. For example: America may be labour scarce in terms of no. of workers

(i) It is a trade restriction that sets a limit on the quantity of a good that can be imported into a country in a given period of time.
(ii) Quotas are used to benefit the producers of good in that economy.

S.No	Balance of Trade (BOT)	Balance of Payments (BOP)
1	Only export and import of commodities are included in BoT	Export and import of commodities and services are included in BoP
2	i.e. Movement of goods or visible trade	Trade in both visible and non visible items.

(i) The equilibrium rate of exchange is determined in the foreign exchange market according to the general theory of value, by the interaction of demand and supply,
(ii) Y axis represents exchange rate, be cos value of rupee in terms of dollars
(iii) X axis represents demand and supply of forex.
(iv) E is the equilibrium point where DD intersects SS. The exchange rate is P₂.

Single Factoral Terms of Trade
(i) According to Viner, the single factoral terms of trade is an improvement over the commodity terms of trade.
(ii) It represents the ratio of export. price index to the import price index adjusted for changes in the productivity of factors in the production of exports.
\(\mathrm{T}_{\mathrm{f}}=\left(\mathrm{P}_{\mathrm{x}} / \mathrm{P}_{\mathrm{m}}\right) \mathrm{F}_{\mathrm{x}}\)
(iii) T_f is single factoral terms of trade index.
(iv) F_x is productivity in exports.
Double Factoral Terms of Trade
\(\mathrm{T}_{\mathrm{ff}}=\left(\mathrm{P}_{\mathrm{x}} / \mathrm{P}_{\mathrm{m}}\right)\left(\mathrm{F}_{\mathrm{x}} / \mathrm{F}_{\mathrm{m}}\right)\)
(i) It takes into account the productivity in country's exports and productivity of foreign factors.
(ii) F_m is import index (which is measured as index cost in terms of quantity of factors of production employed per unit) of imports.