Benefits of international trade

A country has an absolute advantage when it can produce a good using fewer resources (or more output per unit of input) than another country.

Countries trade because they have different factor endowments, climates, and levels of technology, meaning no country can efficiently produce everything it needs. Trade allows access to a wider variety of goods at lower cost.

Specialisation means a country concentrates its resources on producing the goods where it has a comparative advantage, then trades for other goods it needs.

Without trade, a country consumes on or inside its PPC. With specialisation and trade, it can consume at a point beyond its PPC, demonstrating that trade increases consumption possibilities.

A country has a comparative advantage in producing a good when it can produce it at a lower opportunity cost than another country, even if it does not have an absolute advantage.

Factor endowments are the quantities of land, labour, capital, and entrepreneurship that a country possesses. Differences in endowments explain why countries specialise in different goods.

A straight-line PPC means constant opportunity costs — the same amount of one good must be given up for each additional unit of the other, regardless of the production point.

Absolute advantage compares total productivity (who produces more). Comparative advantage compares opportunity costs (who gives up less). A country can have comparative advantage without absolute advantage.

Saudi Arabia has large oil reserves (land/natural resources) so it exports oil, while Japan has a highly skilled workforce (labour/capital) so it exports electronics and vehicles.

Countries lack certain natural resources, face different climates, have varying levels of technology, and cannot produce all goods at the lowest cost. Trade allows them to overcome these limitations.

Country A. Its opportunity cost of 1 car = 2 bikes. Country B's opportunity cost of 1 car = 5 bikes. Country A gives up fewer bikes per car.

Their combined consumption point lies beyond the individual PPCs. Each country produces only the good where it has comparative advantage, then trades, allowing both to consume more than they could alone.

When countries specialise in goods where they are relatively more efficient and trade for the rest, total world output increases beyond what each country could produce alone.

Even if one country is better at producing everything (absolute advantage in all goods), both countries still benefit from trade if they specialise according to comparative advantage, because total output increases.

The terms of trade (exchange ratio) must fall between the two countries' domestic opportunity cost ratios. This ensures both countries get the traded good more cheaply than producing it domestically.

1) Assumes constant opportunity costs (straight-line PPC). 2) Ignores transport costs. 3) Assumes perfect factor mobility within countries but not between them.

The terms of trade measure the ratio of average export prices to average import prices, expressed as an index: ToT = (Index of export prices ÷ Index of import prices) × 100.

Free trade is international trade without government-imposed barriers such as tariffs, quotas, or subsidies. Goods and services move freely across borders based on market forces.

1) Greater consumer choice and lower prices. 2) Increased competition drives efficiency. 3) Economies of scale from larger markets. 4) More efficient allocation of resources through specialisation.

The real world has many countries trading thousands of goods. The simple two-country model does not capture the complexity of global supply chains, multiple trading partners, and service trade.

An improvement (increase) means export prices rise relative to import prices. The country can buy more imports for a given quantity of exports. However, it may reduce export competitiveness.

A deterioration (decrease) means export prices fall relative to import prices. The country must export more to buy the same quantity of imports. This is common for primary commodity exporters.

While trade may increase total national output, the gains may not be shared equally. Workers in industries that lose comparative advantage may become unemployed, increasing inequality.

By opening up larger international markets, firms can produce on a bigger scale, lowering their average costs of production. This benefits consumers through lower prices.

Resources flow to their most productive uses when trade barriers are removed. Countries produce goods where they have comparative advantage, and global resources are allocated more efficiently.

1) Changes in world demand/supply for exports or imports. 2) Exchange rate changes — appreciation raises export prices in foreign currency, improving ToT but potentially reducing competitiveness.

Depending heavily on one or two exports makes a country vulnerable to price fluctuations, demand shocks, and changes in comparative advantage. Diversification provides more economic stability.

No. The theory ignores negative externalities such as pollution from production or transport. Trade may increase output but also increase environmental degradation, which is not captured in the model.

Free trade allows UK consumers to buy bananas from tropical countries at low cost. Without trade, bananas would either be unavailable or extremely expensive to grow in greenhouses domestically.

Higher export prices can reduce the volume of exports sold if demand is elastic. This could worsen the current account and reduce export revenue, despite each unit being worth more.

Calculate the OPPORTUNITY COST for each country for each good. Country with the LOWER opportunity cost has CA in that good. Example: if Country A makes 10 X or 5 Y, OC of 1 X = 0.5Y. If Country B makes 8 X or 8 Y, OC of 1 X = 1Y. Country A has CA in X (0.5Y < 1Y).

Country M: OC of 1 cloth = 20/60 = 1/3 wine. OC of 1 wine = 60/20 = 3 cloth. Country N: OC of 1 cloth = 40/40 = 1 wine. OC of 1 wine = 40/40 = 1 cloth. M has CA in CLOTH (1/3 < 1). N has CA in WINE (1 < 3). M should export cloth, N should export wine.

ABSOLUTE advantage: producing MORE of a good with the same resources (higher productivity). COMPARATIVE advantage: producing a good at LOWER OPPORTUNITY COST. A country can have absolute advantage in BOTH goods but can only have CA in ONE. Trade is based on CA, not absolute — even less productive countries benefit.

ToT = the rate at which one good is exchanged for another. For BOTH countries to gain from trade, the ToT must fall BETWEEN their opportunity costs. Example: if OC of cloth is 1/3 wine (M) and 1 wine (N), ToT must be between 1/3 and 1 wine per cloth for BOTH to benefit.

Compare what each country can consume WITHOUT trade (PPC) versus WITH trade (specialise + exchange). If M fully specialises in cloth (60) and trades 30 cloth for wine at ToT 1:0.5 → gets 15 wine. Before trade, 30 cloth cost 10 wine. M gains 5 extra wine. Both countries consume beyond their PPC.

CA theory assumes: constant OC, perfect factor mobility, no transport costs, no trade barriers. In reality: 1) Increasing OC (concave PPC). 2) Transport costs may outweigh gains. 3) Tariffs and quotas restrict trade. 4) Structural unemployment during adjustment. 5) Terms of trade may be unfair (unequal bargaining power).

The TPC shows the combinations of goods a country can consume WITH trade. It lies OUTSIDE the PPC, showing that trade allows consumption beyond domestic production capacity. The TPC's slope is determined by the terms of trade (not by domestic opportunity costs).

Start from the point of FULL SPECIALISATION (where the country makes only the CA good). Draw a line with slope = ToT. The TPC touches the PPC at the specialisation point and extends beyond the PPC for the other good. The area between TPC and PPC = gains from trade.

The TPC ROTATES OUTWARD (pivoting from the specialisation point). Better ToT = the country gets MORE of the other good per unit exported. This means GREATER gains from trade. Conversely, worsening ToT rotate the TPC inward, reducing trade gains. At the extreme, TPC could fall inside PPC (losses).