International Trade

Comparative advantage, terms of trade, trading blocs & protectionism — the global economy essentials

SPEC 4.1 • A GLOBAL PERSPECTIVE

Key Definitions

These are exact mark-scheme definitions — learn them word-for-word.

Absolute Advantage

When a country can produce more of a good than another using the same resources / at lower absolute cost.

Comparative Advantage

When a country can produce a good at a lower opportunity cost than another country — the basis for mutually beneficial trade.

Terms of Trade

The ratio of export prices to import prices. Measures the purchasing power of exports in terms of imports.

Protectionism

Government policies that restrict free trade to protect domestic industries from foreign competition.

Globalisation

The increasing economic integration and interdependence of national economies through trade, investment, migration and the spread of technology.

6 Factors Driving Globalisation

Trade liberalisation: WTO rounds reducing tariffs and quotas since 1947

Advances in transport: Containerisation → dramatic fall in shipping costs per unit

ICT revolution: Internet, mobile communications → globalisation of services

Financial liberalisation: Removal of capital controls → free movement of capital

Growth of MNCs: Global production chains, FDI, offshoring

Rise of trading blocs: EU, ASEAN, USMCA → regional integration reduces barriers

Impacts of Globalisation

Both sides are required for AO4 evaluation marks.

StakeholderBenefits (+)Costs (−)

ConsumersLower prices, greater product varietyJob losses in uncompetitive domestic sectors

ProducersLarger export markets, cheaper imported inputs, offshoring lowers costsIncreased competition from imports, wage pressure

WorkersHigher demand in competitive sectors; MNC FDI creates employment in developing countriesImport-competing sector workers face job losses and wage stagnation

GovernmentsTrade revenue, higher GDP via export growth"Race to the bottom" on corporation tax; loss of policy sovereignty

EnvironmentTechnology transfer; higher standards spread globallyCarbon leakage; transport emissions; weaker regulation in some host countries

Exam Tip

In a 25-mark essay, always discuss at least two different stakeholder groups and use real-world context (e.g. "MNCs such as Apple relocating production to China"). This is how you hit AO2 application marks.

Comparative Advantage

The Ricardian model: even if one country has absolute advantage in everything, both countries gain from trade if they specialise in the good they produce at lower opportunity cost.

The Logic

Country A is "better" at producing both goods. But Country A has a relatively bigger advantage in one good. Country B has a relatively smaller disadvantage in the other. Both specialise → both gain from trade.

Exam Tip

Chain of reasoning: Identify opportunity costs → Compare → Country with lower OC has comparative advantage → Specialisation → Trade at ratio between the two OCs → Both countries gain.

Worked Example: Comparative Advantage

01Calculation — Data Response Style

Output per worker per day:

CountryWheat (units)Cloth (units)

Country A10050

Country B6040

Step 1: Calculate opportunity costs

Country A: OC of 1 wheat = 50/100 = 0.5 cloth | OC of 1 cloth = 100/50 = 2 wheat

Country B: OC of 1 wheat = 40/60 = 0.67 cloth | OC of 1 cloth = 60/40 = 1.5 wheat

Step 2: Compare

Country A has lower OC in wheat (0.5 < 0.67) → comparative advantage in wheat.

Country B has lower OC in cloth (1.5 < 2) → comparative advantage in cloth.

Step 3: Trade ratio

Beneficial trade occurs at any exchange ratio between 0.5 and 0.67 cloth per wheat (or equivalently 1.5 to 2 wheat per cloth).

Limitations of Comparative Advantage

These are your AO4 evaluation points — examiners expect you to challenge the model.

7 Key Limitations

Assumes constant opportunity costs — in reality, OCs rise as production scales up

Assumes no transport costs — trade must be free and frictionless

Assumes free trade — tariffs, quotas and NTBs undermine gains

Dynamic comparative advantage — a country's CA can change over time (e.g. South Korea in electronics)

Factor immobility — displaced workers cannot immediately enter expanding industries; transition costs are real and can be permanent

Environmental costs — specialisation in primary commodities can lead to resource depletion

Infant industry argument — developing industries may not yet have achieved their CA and need protection

Examiner Alert

Weak students list limitations without developing the chain of reasoning. Don't just write "transport costs" — explain why: "If transport costs exceed the cost savings from specialisation, the gains from trade are eliminated and countries may produce domestically despite having higher opportunity costs."

Terms of Trade

Terms of Trade (ToT)

The ratio of export prices to import prices — measures the purchasing power of exports in terms of imports.

ToT = (Index of Export Prices ÷ Index of Import Prices) × 100

Improvement (Rise in ToT)

Exports become relatively more expensive vs imports. A given volume of exports buys more imports → better living standards. But may reduce export competitiveness → lower export volume.

Deterioration (Fall in ToT)

Exports buy fewer imports. Developing countries exporting primary commodities often face long-run deterioration (Prebisch-Singer hypothesis) as commodity prices fall relative to manufactured goods.

Worked Example: Terms of Trade

02Calculation — 4 Mark Style

In 2023, a country's export price index was 115 and its import price index was 125. In 2024, its export price index rose to 120 and its import price index fell to 110. Calculate the ToT in each year and explain the change.

2023: ToT = (115 ÷ 125) × 100 = 92

2024: ToT = (120 ÷ 110) × 100 = 109.1 (1 d.p.)

Interpretation: The ToT improved from 92 to 109.1. This means the purchasing power of exports has increased — each unit of exports now buys more imports. This could be caused by rising demand for exports or falling cost of imports. However, the higher relative export price could reduce the volume of exports if demand is price elastic (AO4).

Exam Tip

Always state the formula, show your working, and include units/interpretation. Method marks are available even if your arithmetic is wrong.

Trading Blocs

Four levels of economic integration — definitions are required in the exam.

TypeDefinitionExample

Free Trade AreaMembers eliminate tariffs/quotas between themselves but each keeps own external trade policyCPTPP (UK joined 2023)

Customs UnionFTA + a common external tariff on goods from non-membersEU (also a CU)

Common MarketCustoms union + free movement of factors of production (labour and capital)EU Single Market

Monetary UnionCommon market + shared currency and single monetary policyEurozone (19 members)

Exam Tip

Each level adds to the previous one. Think of it as a ladder of integration. A monetary union includes all the features of an FTA + customs union + common market.

Trade Creation vs Diversion

This is a critical evaluation framework for assessing whether trading blocs increase or decrease welfare.

Trade Creation ✓

Members switch from high-cost domestic production to lower-cost production from bloc partners → more efficient allocation → lower prices for consumers → welfare gain.

Trade Diversion ✗

Lower-cost global producers are displaced by higher-cost bloc members because the common external tariff makes them uncompetitive → welfare loss.

Evaluation Rule

The net welfare effect of joining a trading bloc depends on whether trade creation > trade diversion. This is a top-mark evaluation point. Also note: regional blocs can conflict with the WTO's multilateral approach (Article XXIV).

Types of Protectionism

TypeHow it WorksKey Feature

TariffTax on imports → raises price → domestic producers protected, gov earns revenueConsumers pay higher prices; creates deadweight loss

QuotaLegal limit on import quantity → domestic price rises above world priceGovernment earns nothing — quota rents go to importers

Domestic SubsidyLowers domestic production costs → firms compete on priceConsumers pay world price but government pays subsidy cost

Non-Tariff BarriersTechnical standards, safety requirements, labelling regulations, bureaucratic delaysHarder to negotiate away than tariffs; increasingly common

Tariff Diagram

Diagram required for top marks. This is a key diagram for Paper 2 and Paper 3.

Diagram Reading

Tariff raises price from Pw to Pw+T → domestic output rises (Qs1→Qs2), domestic demand falls (Qd1→Qd2), imports shrink. Two deadweight loss triangles = welfare loss from production and consumption inefficiency.

For & Against Protectionism

Arguments FOR

Infant industry: New industries need time to achieve economies of scale before competing globally

National security: Self-sufficiency in strategic goods (food, energy, defence)

Retaliation: Response to unfair trading practices (e.g. dumping)

Protecting jobs: Prevent mass unemployment in declining industries

Strategic trade policy: Support industries with positive externalities

Arguments AGAINST

Higher consumer prices: Tariffs directly raise prices → lower consumer surplus

Retaliation risk: Trade wars (e.g. US-China tariffs 2018–)

Efficiency loss: Protected industries lack incentive to innovate

Undermines comparative advantage: Resources misallocated away from efficient industries

Infant industry may never "grow up": Protection becomes permanent once lobbying starts

The WTO & Trade Liberalisation

World Trade Organisation (WTO)

An international body that promotes trade liberalisation by negotiating reductions in trade barriers and providing a framework for resolving trade disputes between member countries.

Key WTO Functions

Negotiation: Multilateral trade rounds to reduce tariffs globally (e.g. Doha Round — stalled)

Dispute resolution: Arbitration panel settles trade disagreements between members

Monitoring: Reviews members' trade policies for compliance

Most Favoured Nation (MFN): Trade concessions given to one member must apply to all

Examiner Alert

Students often confuse the WTO with trading blocs. The WTO promotes multilateral free trade (all members). Trading blocs are regional/preferential arrangements. The WTO allows blocs under Article XXIV but they can conflict with multilateral principles because they discriminate against non-members.

Pattern of Trade

The spec requires you to explain factors influencing which countries trade what, and with whom.

Factors Influencing Trade Patterns

Comparative advantage: Countries export goods they produce at lower OC — determines specialisation

Impact of emerging economies: China and India's growth has shifted manufacturing and services trade flows; increased South-South trade

Growth of trading blocs: EU, ASEAN, CPTPP — intra-bloc trade increases at the expense of extra-bloc trade

Changes in relative exchange rates: Depreciation makes exports cheaper → boosts export volume → shifts trade balance

Exam Tip

Apply to context: UK's trade pattern post-Brexit shifted — more trade with non-EU partners, but also higher friction with EU. China's Belt and Road Initiative reshapes developing country trade flows. These are strong AO2 application points.

Examiner Alerts

AO4 Evaluation Toolkit

Use these evaluative frames in any essay on international trade:

5 Evaluation Points for Trade Essays

Short run vs long run: "In the short run, protectionism may save jobs; in the long run, it reduces competitive pressure and innovation, leading to lower productivity growth."

Elasticity: "The impact of a tariff on import volume depends on PED for imports — if demand is price inelastic (e.g. essential commodities with few substitutes), the tariff raises revenue but barely reduces imports."

Stakeholder analysis: "While domestic producers and their workers benefit from tariff protection, consumers face higher prices and reduced choice — the net welfare effect is typically negative (as shown by the two DWL triangles)."

Context/magnitude: "The size of the tariff matters — a 5% tariff on steel may have minimal impact, but Trump's 25% tariff on Chinese goods significantly disrupted supply chains."

Retaliation & dynamic effects: "Protectionism invites retaliation, potentially triggering a trade war that reduces global trade volumes and harms all participants — as seen in the US-China tariff escalation."

Practice Question

Question (4 marks): The table below shows output per worker per week for two countries.

CountryCarsTextiles

Japan8040

Bangladesh1020

(a) Calculate the opportunity cost of producing one car in each country. (2 marks)

(b) Identify which country has comparative advantage in textiles and explain why. (2 marks)

(a)

Japan: OC of 1 car = 40/80 = 0.5 textiles. Bangladesh: OC of 1 car = 20/10 = 2 textiles. ✓✓

(b)

Bangladesh has comparative advantage in textiles because: OC of 1 textile in Bangladesh = 10/20 = 0.5 cars, vs Japan OC of 1 textile = 80/40 = 2 cars. Bangladesh has the lower opportunity cost in textiles (0.5 < 2). ✓✓

Practice Question

Question (25 marks — Paper 2 style):

"Evaluate the view that protectionist policies are never justified."

Plan your answer using the DEF → DIAG → ANALYSE → APPLY → EVAL golden rule.

Plan:

Intro: Define protectionism, state thesis — "never justified" is too strong; circumstances exist where short-run protection may be warranted.

KAA1:

Against protectionism — tariff diagram showing DWL, consumer surplus loss. Apply: US steel tariffs raised costs for downstream manufacturers like car producers.

KAA2:

For protectionism — infant industry argument. Developing countries may need temporary protection to achieve economies of scale. Apply: South Korea's protection of electronics industry in 1960s–70s.

Eval 1:

"However, the infant industry argument assumes governments can correctly identify which industries to protect — in practice, government failure means protection is often captured by lobbying from uncompetitive firms." (Short run vs long run)

Eval 2:

"The impact depends on the magnitude and duration of protection — targeted, temporary tariffs with a clear exit strategy differ fundamentally from permanent, broad-based protectionism." (Magnitude)

Concl:

"On balance, protectionism is rarely justified in the long run because it undermines comparative advantage and invites retaliation. However, in specific cases — infant industries in developing economies, national security concerns — short-term, well-targeted measures can be welfare-enhancing, provided they include sunset clauses."

Summary

Key Concepts

ConceptKey Point

Comparative AdvantageLower opportunity cost → specialise → both gain from trade

Terms of TradeToT = (Export Price Index ÷ Import Price Index) × 100

Trading BlocsFTA → Customs Union → Common Market → Monetary Union

ProtectionismTariffs, quotas, subsidies, NTBs — all reduce welfare (DWL)

WTOMultilateral trade liberalisation — can conflict with regional blocs

Must-Know Diagrams

✓ Tariff diagram (Pw, Pw+T, DWL triangles, gov revenue)

✓ Comparative advantage table with OC calculations

Must-Know Definitions

✓ Comparative advantage

✓ Terms of trade (+ formula)

✓ All 4 trading bloc types

✓ Protectionism, tariff, quota, NTB

Exam Tip

This topic appears on Paper 2 (macro/global) and Paper 3 (synoptic). For Paper 3, link trade to macro effects: tariffs → higher prices → cost-push inflation → reduced real income → lower AD. Always bridge micro and macro.