2.6.2a Comparative advantage and benefits of trade (A-level only)

Trade Is Based on Comparative Advantage, Not Absolute Advantage

1. Absolute advantage is producing a good using fewer resources than another country.
2. Comparative advantage is producing a good at a lower opportunity cost.
3. The law of comparative advantage is the basis for the gains from trade.
4. Total output rises when each country specialises in its lower opportunity-cost good.

A Two-Country Example Shows How Opportunity Costs Differ

1. Suppose one worker in Country A makes $10$ wheat or $5$ cloth.
2. One worker in Country B makes $4$ wheat or $4$ cloth.
3. In A, one cloth costs $\frac{10}{5}=2$ wheat; in B, one cloth costs $\frac{4}{4}=1$ wheat.
4. So B has the lower opportunity cost in cloth and A in wheat.

A Country with an Absolute Advantage in Both Goods Still Gains From Trade

1. Country A has an absolute advantage in both goods here.
2. But it cannot make everything, so it must choose.
3. Comparative advantage shows where that choice should fall.
4. So even the more productive country gains by specialising.

1. Specialisation by comparative advantage raises total output.
2. Trade then lets both countries consume beyond their own frontier.
3. So both can end up with more of both goods.
4. This is the core case for international trade.

Compare Opportunity Costs to Decide Who Should Specialise

Trade Brings Gains From Lower Prices and Scale, but Also Real Costs

1. International trade brings gains beyond the basic model.
2. These include lower prices, wider choice and economies of scale.
3. But specialisation and trade also carry costs.
4. The gains are unevenly spread between and within countries.

The Main Gains Are Lower Prices, Wider Choice and Economies of Scale

1. Consumers gain a wider range of goods at lower prices.
2. Firms exploit economies of scale by selling to a larger market.
3. Greater competition raises efficiency and choice.
4. Trade can also transfer technology between countries.

Trade Also Brings Costs Such as Structural Unemployment and Dependence

1. A country can become over-dependent on a few trading partners.
2. Declining sectors can suffer structural unemployment.
3. Open economies are more exposed to external shocks.
4. Trade can also bring environmental damage.

Whether the Gains Outweigh the Costs Depends on How They Are Distributed

1. For trade: lower prices, wider choice and scale raise living standards.
2. Against: structural unemployment, dependence and shocks impose costs.
3. The gains are spread unevenly, so some groups lose out.
4. On balance, trade tends to raise total welfare, but the uneven spread of gains and losses means the outcome depends on how far the losers are supported.

Weigh the Gains Against the Costs and Note Their Uneven Distribution

Comparative Advantage Relies on Simplifying Assumptions That Limit the Model

1. The theory of comparative advantage rests on simplifying assumptions.
2. These include constant returns to scale and no transport costs.
3. It also assumes factor mobility within countries but not between them.
4. And it assumes just two countries, two goods and costless trade.

The Main Assumptions Are Constant Returns, No Transport Costs and Limited Factor Mobility

1. It assumes constant returns to scale as output changes.
2. It assumes no transport costs between countries.
3. It assumes factors move freely within but not between countries.
4. It assumes only two countries and two goods and costless trade.

The Assumptions Matter Because Transport Costs, Externalities and Shifting Advantage All Limit the Model

1. Transport costs reduce or reverse the gains from trade.
2. Externalities such as pollution are left out.
3. Comparative advantage is dynamic and can shift over time.
4. Trade barriers exist and distort the pattern of trade.

The Model Remains a Useful Framework Despite Its Unrealistic Assumptions

1. For the model: it captures the core insight that opportunity cost drives trade.
2. Against: its assumptions are unrealistic and static.
3. Transport costs, externalities and shifting advantage all limit it.
4. On balance, comparative advantage is a useful framework for why trade happens, but its unrealistic assumptions mean it should guide thinking rather than describe trade literally.

State the Assumptions Clearly Before Evaluating Them

The Pattern of Trade Is Continually Reshaped by Comparative Advantage and Policy

1. The pattern of trade is which goods a country trades and with whom.
2. It is shaped by comparative advantage and how that changes.
3. It also reflects trading blocs, exchange rates and relative costs.
4. Trade flows shift over time as competitiveness and policy change.

Comparative Advantage, Emerging Economies, Blocs and Exchange Rates Shape the Pattern

1. Comparative advantage sets the initial pattern of trade.
2. The rise of emerging economies shifts where goods are made.
3. Trading blocs and bilateral deals redirect trade flows.
4. Exchange rates and relative productivity change competitiveness.

Patterns Change as Comparative Advantage, Productivity and Exchange Rates Shift

1. A country can gain or lose comparative advantage over time.
2. Rising productivity abroad shifts production there.
3. New trade agreements open or divert flows.
4. A change in the exchange rate alters relative prices.

Trade Data Should Be Read as Dynamic and Linked to Underlying Causes

1. Trade data show the direction and composition of flows.
2. Shifts in the data can be linked to underlying causes.
3. Competitiveness and policy explain much of the change.
4. So patterns should be read as dynamic, not fixed.

Link Shifts in Trade Data to Their Underlying Causes

2.6.2b Protectionist policies (A-level only)

Protectionist Policies Use Tariffs, Quotas and Export Subsidies to Shield Domestic Industry From Imports

1. Protection uses barriers to shield domestic industries from imports.
2. A tariff is a tax on imports; a quota is a limit on the quantity imported.
3. Export subsidies lower costs for domestic producers, helping them undercut foreign rivals at home and abroad.
4. Non-tariff barriers include regulations, embargoes and administrative red tape.

Tariffs, Quotas, Subsidies and Non-Tariff Barriers Each Restrict Trade in a Different Way

1. A tariff is a tax added to the price of an import.
2. A quota caps the volume of a good that can be imported.
3. Export subsidies cut the costs faced by domestic producers and exporters.
4. Non-tariff barriers raise the cost or difficulty of importing.

A Tariff Raises the Domestic Price, Cuts Imports and Creates a Deadweight Welfare Loss

1. The tariff raises price, so consumers buy less and pay more.
2. Domestic producers supply more at the higher price.
3. The government gains tariff revenue on the imports that remain.
4. Two welfare triangles are lost as deadweight loss.

A Tariff Earns Government Revenue, Whereas a Quota Hands the Scarcity Gain to Importers

1. Tariffs raise revenue; quotas do not.
2. Export subsidies support producers without taxing consumers directly.
3. Non-tariff barriers work through cost and complexity.
4. So the tools differ in how they restrict trade and who pays.

Always Label Price, Imports, Government Revenue and the Welfare Loss on Your Tariff Diagram

Protection Can Defend Jobs and Infant Industries, but It Risks Inefficiency, Higher Prices and Retaliation

1. Protectionism can be defended on several grounds.
2. These include the infant industry and anti-dumping arguments.
3. It is also used to protect jobs and strategic industries.
4. But free trade raises efficiency and protection risks retaliation.

Infant Industries, Anti-Dumping, Jobs and Revenue Form the Main Case for Protection

1. The infant industry argument protects new firms until they grow.
2. Anti-dumping action guards against goods sold below cost.
3. Protection can defend jobs and strategic or security industries.
4. Tariffs can also raise revenue or ease a current account deficit.

Free Trade Raises Efficiency and Consumer Choice, so Protection Carries a Real Cost

1. Free trade raises efficiency through comparative advantage.
2. It gives consumers lower prices and wider choice.
3. Protection can shelter inefficient producers from competition.
4. It can also trigger retaliation and a trade war.

Targeted, Temporary Protection Can Be Justified, but Broad or Permanent Protection Tends to Reduce Welfare

1. For protection: it can defend jobs and nurture infant industries.
2. Against: it raises prices, shelters inefficiency and invites retaliation.
3. Infant industry protection is hard to remove once granted.
4. On balance, targeted and temporary protection can be justified in specific cases, but broad or permanent protection tends to reduce welfare, so the case depends on how narrowly and briefly it is applied.

Set Each Argument for Protection Against the Free-Trade Reply, Then Reach a Supported Judgement

2.6.2c Customs unions, the SEM and the WTO (A-level only)

A Customs Union, the Single European Market and the WTO Each Deepen Trade Integration in a Distinct Way

A Customs Union Combines Free Internal Trade with a Common External Tariff

1. A customs union removes tariffs on trade between its members.
2. It also applies a common external tariff to imports from non-members.
3. This distinguishes it from a free trade area, where members keep their own separate external tariffs.

A Customs Union Can Both Create and Divert Trade

1. Trade creation occurs when cheaper output from a partner replaces costly home production, raising welfare.
2. Trade diversion occurs when the common external tariff shifts trade from a lower-cost outside producer to a dearer member, lowering welfare.
3. Whether joining a customs union raises welfare depends on which of the two effects is larger.

The Single European Market Rests on Four Freedoms

1. The Single European Market (SEM) allows free movement of goods, services, capital and people across member states.
2. It removes not only tariffs but also many non-tariff barriers, such as differing product standards and regulations.
3. It is deeper than a customs union because factors of production, not just goods, can move freely.

Membership of the Single Market Brings Gains and Costs

1. Firms gain tariff-free access to a large market and can achieve economies of scale.
2. Consumers gain wider choice and lower prices from stronger competition.
3. But members pool some sovereignty, contribute to shared budgets and expose weaker industries to competition.
4. The UK left the Single European Market and the customs union at the end of 2020.
5. It now trades with the EU under a free trade agreement, which removes tariffs but not all the checks and paperwork that single-market membership had eliminated, a concrete illustration of how a free trade area is shallower than deeper integration.

The WTO Provides a Rules-Based System for Multilateral Trade

1. The World Trade Organisation (WTO) sets and enforces the rules of international trade.
2. It negotiates multilateral agreements, through trade rounds, that lower barriers between its members.
3. It runs a dispute settlement process and can authorise retaliation when a member breaks the rules.

The WTO's Effectiveness Is Debated

1. In its favour, it has lowered many barriers and settled numerous disputes between members.
2. Against it, recent rounds such as Doha have stalled and its enforcement powers are limited, with its appellate body left unable to hear new appeals in recent years.
3. Regional blocs, which favour members over outsiders, can also pull against its multilateral goal.