Cambridge A Level Economics: Absolute and comparative advantage, free trade and the terms of trade (9708) – Revision Notes

These notes condense section 6.1 (outcomes 6.1.1 to 6.1.4) of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topics 1 to 6 are AS Level content, so this is AS Level content and it is assumed knowledge for A Level Papers 3 and 4. For full explanations read the study guide, then test yourself with the practice set. The course hub and checklist show where this fits, and the free diagnostics help you decide what to revise first. Every country and figure below is invented.

6.1.1 Key definitions

Term	Meaning
Absolute advantage	Produces a good with fewer resources, or more of it from the same resources
Comparative advantage	Produces a good at a lower opportunity cost
Opportunity cost	The next best alternative given up
Specialisation	Concentrating production on goods with a comparative advantage
Free trade (trade liberalisation)	Trade without tariffs, quotas or other barriers
Trading possibility curve (TPC)	The combinations of two goods a country can consume after specialising and trading at given terms
Terms of trade	The rate at which exports exchange for imports

Method: find the comparative advantage

1. Put the data in one form: output per worker (or per day) or hours per unit.
2. For each country, work out the opportunity cost of one good in terms of the other (output of the other good divided by output of this good, or hours of this good divided by hours of the other).
3. Compare the same good across countries. The lower opportunity cost marks the comparative advantage.
4. Check that each country has the advantage in a different good.

Worked reminder 1

Country C produces 12 tonnes of rice or 8 metres of fabric per worker-day. Country D produces 6 tonnes of rice or 3 metres of fabric.

	Opportunity cost of 1 tonne of rice	Opportunity cost of 1 metre of fabric
C	8 ÷ 12 = 0.67 fabric	12 ÷ 8 = 1.5 rice
D	3 ÷ 6 = 0.5 fabric	6 ÷ 3 = 2 rice

C has an absolute advantage in both goods (more of each per worker-day). D has the comparative advantage in rice (0.5 is below 0.67). C has the comparative advantage in fabric (1.5 is below 2).

The exchange price of 1 metre of fabric must lie between 1.5 and 2 tonnes of rice. At 1.75 tonnes, C earns 0.25 tonne more than it could get by making rice itself, and D pays 0.25 tonne less than it would give up making fabric itself. Both gain on every unit traded.

6.1.2 Benefits of specialisation and free trade

• Output and consumption possibilities are larger than without trade.
• The TPC lies outside the PPC at any terms of trade that differ from the home opportunity cost.
• Consumers gain choice and lower prices; firms gain larger markets, economies of scale and access to cheaper inputs.
• Competition from imports encourages efficiency and innovation.
• Export growth can raise income and jobs.

TPC quick facts

Feature	Detail
Axes	Quantities of the two goods consumed
Start point	The country’s PPC intercept for the good it specialises in
Other end	The amount of the other good that all of that output could buy at the agreed terms
Slope	Set by the terms of trade, not by domestic opportunity cost
Better terms of trade	The TPC pivots outwards

Example: Country C could make 80 metres of fabric from 10 workers. At 1.75 tonnes of rice per metre, all fabric could be swapped for 80 × 1.75 = 140 tonnes of rice. Its PPC would allow at most 120 tonnes if everyone made rice. The TPC runs from 80 metres to 140 tonnes, outside the PPC.

6.1.3 The terms of trade

Item	Detail
Formula	(Index of average export prices ÷ index of average import prices) × 100
Rise in the index	Improvement: exports buy more imports
Fall in the index	Worsening: exports buy fewer imports
Base year	100
Percentage change	(new index − old index) ÷ old index × 100

Worked reminder 2

Export price index 108 and import price index 90 give 108 ÷ 90 × 100 = 120. If the index later falls to 108, the change is (108 − 120) ÷ 120 × 100 = −10%. A fall of 12 index points is a fall of 10%, not 12%.

Another check: a country sells 200 units at 15 cu and imports cost 12 cu. Exports buy 200 × 15 ÷ 12 = 250 import units.

Causes of change

Improves the index	Worsens the index
Rising world demand for exports	Falling world demand for exports
Rising export prices from inflation or scarce supply	Rising import prices (such as fuel or raw materials)
Appreciation of the home currency (with home-currency pricing)	Depreciation of the home currency
Falling world prices of imports	New competing suppliers of the export

Productivity gains can lower export prices, which lowers the index but raises competitiveness.

Impact chain

1. State the direction of change in the index.
2. Say what it means for the quantity of imports each unit of exports buys.
3. Link to export revenue through the price elasticity of demand: elastic means revenue falls when prices rise; inelastic means revenue rises.
4. Link to the current account, living standards, inflation (imported costs) and competitiveness.
5. Judge: the cause matters. A worsening caused by higher productivity may be good news; one caused by weak world demand is not.

6.1.4 Limitations of the theories

Limitation	Effect on the case for trade
Transport and other trade costs	Cut or remove the gains
Increasing opportunity costs	Complete specialisation is unlikely; the advantage narrows
Imperfect factor mobility	Retraining costs and unemployment
Static view	Comparative advantage changes over time; infant industries
Dependence on a narrow range of exports	Exposure to price falls and supply shocks
Assumes perfect competition, full employment, perfect information and no barriers	Reality differs, so the gains are smaller or uneven
Unequal distribution	Some groups and regions lose
Environmental costs of extra transport and production	Not counted in the model

Evaluation prompts

• How large are the trade costs compared with the gain?
• How easily can workers move to the growing industry, and over what time?
• How diversified are the exports?
• Is the advantage likely to last?
• Who gains and who loses?

Quick self-test

1. Define comparative advantage.
2. Country C makes 12 tonnes of rice or 8 metres of fabric per worker-day. What is the opportunity cost of 1 metre of fabric?
3. Country D makes 6 tonnes of rice or 3 metres of fabric. Which good does D have a comparative advantage in, compared with C?
4. Between which two values must the price of fabric in rice lie for both C and D to gain?
5. Export price index 108, import price index 90. Calculate the terms of trade.
6. The index rises from 80 to 90. Calculate the percentage change.
7. Export prices fall to 95 and import prices rise to 105 (base 100). Calculate the terms of trade and say whether they improved.
8. State two causes of an improvement in the terms of trade.
9. Why might an improvement in the terms of trade reduce export revenue?
10. What does the TPC show that the PPC cannot?
11. Give two limitations of comparative advantage theory.
12. A country sells 200 units at 15 cu and imports cost 12 cu. How many import units do the exports buy?

Answers

1. The ability to produce a good at a lower opportunity cost than another country.
2. 12 ÷ 8 = 1.5 tonnes of rice.
3. Rice: D gives up 0.5 metre of fabric per tonne, C gives up 0.67.
4. Between 1.5 and 2 tonnes of rice per metre.
5. 108 ÷ 90 × 100 = 120.
6. (90 − 80) ÷ 80 × 100 = 12.5%.
7. 95 ÷ 105 × 100 = 90.5. This is a worsening, since the index is below 100 and fell.
8. For example, higher world demand for exports, a falling price of imported materials, or an appreciating currency.
9. If demand for exports is elastic, the rise in export prices cuts the quantity sold by a larger percentage than the price rise.
10. Consumption possibilities after trade, which can lie outside the PPC.
11. For example, transport costs, increasing opportunity costs, immobile factors, dependence, changing advantage.
12. 200 × 15 ÷ 12 = 250 units.

Where marks are usually lost

• Working out opportunity cost the wrong way up. Check it by asking what is given up.
• Naming the country that produces more as the one with the comparative advantage.
• Giving a price outside the opportunity cost limits and still claiming both countries gain.
• Putting import prices on top of the terms of trade formula.
• Describing a fall in the index as a fall of that many percent.
• Writing that an improvement is always good without discussing elasticity or the cause.
• Listing limitations without explaining their effect on the gains from trade.
• Drawing a TPC that starts at a different place from the PPC, or leaving the axes unlabelled.

Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment (Cambridge International Education). Section 6.1, The reasons for international trade, outcomes 6.1.1 to 6.1.4.