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International Trade
What is international trade?
The world economy is becoming more and more incorporated meaning that single economics are
increasingly reliant on each other
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International trade is the exchange of goods and services over international borders; it is the
engagement of importing and exporting activities
...

Dependency on international trade varies
...
There are different factors that reflect how reliant a country may be,
in some cases:
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The availability of natural resources

If a country lacks availability of natural resources, raw materials etc
...

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Politics

Political attitudes across countries differ, some may be more in favour of international trade
compared to others
...
These are different according to how developed the economy is
...


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Widens consumer choice (developed countries)
Exposes consumers to a variety of commodities that is not easily produces in their domestic
market
...

Encourages specialisation in particular products where they hold comparative advantage
(allocative efficiency)
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Increase in GDP
Gaining access to foreign markets would increase in net exports is an injection to the circular
flow of income and would increase the level of aggregate demand in an economy (C+I+G+(X-

M) =AD) therefore the economy would experience an increase in Real GDP
...

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Development in industries
International trade would allow developing countries to gain access to machinery and
technical expertise that could generate development in certain industries thus increasing
growth
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Disadvantages:
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Local companies may go out of business
International competiveness can cause local companies to experience losses as consumers
may find imports more attractive than domestic products
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Risk of contagion
International trade can cause economies to be more susceptible to external shocks
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Transport costs
The cost of transportation can make the act of trading more costly, regardless of whether or
not a country specialised in a particular good or service

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Developing countries don’t always experience all the benefits from international trade
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It is usually the case with developing
countries to specialise in agriculture (or similar industries), which is a low productivity activity
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Due to reasons such as this, workers
from developing countries lack skills needed for modern production
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The pattern of international trade
It is usual for countries to specialise in goods and services that are more suited to their situation
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Absolute and comparative advantage
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shows how international trade is mutually beneficial

The idea of comparative advantage was first introduced by David Ricardo in 1817 and his theory
helps us to explain patterns of international trade
...

Comparative advantage is present when a country has a ‘margin of superiority’ in the supply/
production of a particular good or service
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It is a country’s ability to
produce a good relatively more efficiently than another country
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Absolute advantage is a country’s ability to produce a good using fewer resources than another
country
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Trade allows countries to benefit from more goods and services by specialising in goods and services
where they have comparative advantage
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The law of comparative advantage
If each country completely specialises, and trade were to occur on a one-unit-to-one-unit basis, the
total output can be increased leading top better allocative efficiency and welfare
...

Therefore the law of comparative advantage states that overall output can be increased if countries
specialise completely in the production of goods where they have comparative advantage
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An example of absolute advantage
Absolute advantage is a country’s ability to produce goods using fewer factors of production
...

Country
India
China

Microwaves
400
800

or
or

Televisions
600
100

We already know that India and China both have an equal number of the same resources
...

Therefore, China has absolute advantage in the production of Microwaves
...

China and India could decide to specialise in the goods they have absolute advantage over
...

If a reasonable exchange rate for microwaves and televisions are found and is accepted by both
parties, then China and India could benefit from an increase in allocative efficiency and economic
welfare
...


Calculating comparative advantage
The theory of comparative advantage states that whichever nation has the lowest opportunity cost,
has a margin of superiority in supply of that good
...

Note: Opportunity cost is the next best alternative foregone
...

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Take India
20 divided by 10 equals 2
10 divided by 20 equals ½
The answer to the division always goes where the second number of the calculation is

The same method applies to China
16 divided by 2 equals 8
2 divided by 16 equals 1/8
Opportunity cost table
India
China

Cotton
1⁄ of a microwave
2
1⁄ of a microwave
8

Microwaves
2 tonnes of cotton
8 tonnes of cotton

So India has more of a comparative advantage in the production of microwaves than China do
because they only have to give up 2 tonnes of cotton
...
As India have the lower opportunity cost in the production of
microwaves, it has the comparative advantage
...
Whereas India would have to give up ½ of a
microwave to produce 1 tonne of cotton
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Exam tip
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It will be useful to learn a couple numerical examples to explain the theory of comparative
advantage, in essay questions, in your exam
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If country C wanted to consume 6
units of product B then it would
only be able to consume 2 units of
product A
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They could then trade
on a one-unit-to-one-unit basis to
expand their consumption
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Free trade
is a term that refers to no obstacles to actions involving importing or exporting
...
The terms of trade is one of the key determinants that identifies who gains from international
trade
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To prevent the ratio
of exports to imports from falling, the country must aim to export at a greater degree
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Global output is increase as countries can produce with more allocative efficiency and
welfare as they determine what goods/ services they should specialise in
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Such as the
assumption of no transport costs for example
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However in reality, protectionism holds barriers to trade
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Governments can agree to deals that cause one of them to
limit their exports
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Economies of scale is the
phenomenon where as a firm grows and its output rises its total costs rise however its average costs
of production per unit fall
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