IB DP Economics: Benefits of international trade – Revision Notes

These revision notes follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. They cover sub-topic 4.1, Benefits of international trade. The benefits and the two free-trade diagrams are SL and HL. Absolute and comparative advantage, the HL calculations and the limitations of the theory are HL only.

For full explanations and worked examples, read the study guide. Then try the practice questions. Also see the IB DP Economics hub, the printable checklist and the free 10-minute diagnostics.

Key terms

Term	Meaning
Export	A good or service sold to buyers in another country
Import	A good or service bought from sellers in another country
World price (Pw)	The price at which the good trades internationally, shown as a horizontal line
Foreign exchange earnings	Foreign currency received from exports
Absolute advantage (HL only)	Producing a good with fewer resources, or more output from the same resources, than another country
Opportunity cost (HL only)	The next best alternative given up
Comparative advantage (HL only)	A lower opportunity cost of a good than a trading partner has

The nine benefits at a glance

Benefit	One-line chain
Increased competition	Foreign rivals force home firms to improve or lose sales
Lower prices	More supply and rivalry reduce prices, so consumers gain
Greater choice	Consumers and firms can pick from more varieties and inputs
Acquisition of resources	Imports bring in materials, energy or technology the country lacks
More foreign exchange earnings	Exports earn foreign currency to pay for imports
Access to larger markets	Sales are not capped by the home population
Economies of scale	Higher output spreads fixed costs, so average cost falls
More efficient resource allocation	Resources shift to what the country does best
More efficient production	Competition and specialisation cut waste

For each benefit in an answer, give the mechanism and name who gains. Add a limit if the command term asks you to go beyond analysis.

Free-trade diagrams

Both diagrams show price up the side, quantity along the bottom, domestic D and S, the no-trade equilibrium and a horizontal line at Pw.

	World price above domestic price	World price below domestic price
Result	Country exports	Country imports
Quantity traded	Qs − Qd (at Pw)	Qd − Qs (at Pw)
Consumers	Pay more, buy less: surplus falls	Pay less, buy more: surplus rises
Producers	Receive more, sell more: surplus rises	Receive less, sell less: surplus falls
Net effect	Gain, because producers gain more than consumers lose	Gain, because consumers gain more than producers lose

Method in steps (HL only calculation)

1. Find the no-trade equilibrium by setting Qd = Qs, to see which case applies.
2. Substitute Pw into the demand and supply equations to find Qd and Qs.
3. Subtract: Qs − Qd for exports, Qd − Qs for imports.
4. Export revenue = Pw × exports. Import expenditure = Pw × imports.

Worked reminder with a fictional market. Qd = 100 − 2P and Qs = 3P − 20. Setting them equal: 120 = 5P, so P = 24 and Q = 52. At Pw = 30, Qd = 40 and Qs = 70, so exports are 30 and revenue is 30 × 30 = 900. At Pw = 16, Qd = 68 and Qs = 28, so imports are 40 and expenditure is 16 × 40 = 640.

Comparative advantage (HL only)

Method in steps

1. Write each country’s maximum output of each good, or the resource cost of one unit.
2. Opportunity cost of X in terms of Y = Y given up ÷ X gained. Find it for both goods and both countries.
3. The lower opportunity cost for a good gives the comparative advantage in that good.
4. Each country specialises in the good where its opportunity cost is lower.
5. Mutually beneficial terms of trade lie strictly between the two countries’ opportunity costs.

Reminder with fictional data. Country J makes 12 shirts or 4 machines. Country K makes 10 shirts or 5 machines.

• Opportunity cost of one machine: J gives up 12 ÷ 4 = 3 shirts, K gives up 10 ÷ 5 = 2 shirts. K has the comparative advantage in machines.
• Opportunity cost of one shirt: J gives up 4 ÷ 12 = ⅓ machine, K gives up 5 ÷ 10 = ½ machine. J has the comparative advantage in shirts.
• Any price between 2 and 3 shirts per machine benefits both.

The linear PPC diagram

• Each PPC is a straight line, so the opportunity cost is constant.
• The line with the shallower slope for a good shows the lower opportunity cost of that good.
• Different slopes are what create gains. With identical slopes there is nothing to gain.
• After specialisation and trade, each country can consume at a point outside its own PPC.
• Label both axes, both intercepts and the pre-trade and post-trade consumption points.

Sources of comparative advantage

Factor endowments, technology, skills, infrastructure and institutions, and past investment. These can change over time.

Limitations of the theory (HL only)

Limitation	Why it matters
Constant opportunity cost assumed	Real opportunity costs often rise with output
No transport or trade costs	These can wipe out a small gain
Resources assumed fully employed and mobile	Displaced workers may be unemployed for long
Over-specialisation	Dependence on one export brings price risk
Perfect competition assumed	Large firms and scale effects change outcomes
Gains uneven	Some groups lose even if the country gains
Non-economic costs left out	Environmental damage is not counted

The guide sets this at evaluation depth. Finish with a judgement: the theory explains why trade can raise output, but its assumptions mean real gains are smaller and less evenly spread.

Must-know distinctions

• Absolute vs comparative advantage: output or resource use, against opportunity cost.
• Exports vs imports on the diagram: Qs − Qd against Qd − Qs.
• Revenue vs expenditure: exports earn revenue, imports cost expenditure, both at Pw.
• Movement along a curve vs a shift: free trade changes the price faced, so quantities move along D and S. The curves themselves do not shift.
• Gain overall vs gain for everyone: trade can raise total surplus while some groups lose.

Quick self-test

1. Outline how access to larger markets benefits a firm.
2. Fictional firm: fixed costs 90 000, variable cost 3 per unit. Calculate average cost at 10 000 units and at 30 000 units.
3. (HL only) With Qd = 100 − 2P and Qs = 3P − 20, state the no-trade price and quantity.
4. (HL only) Using the same market, find exports and export revenue at a world price of 30.
5. (HL only) Using the same market, find imports and import expenditure at a world price of 16.
6. When the world price is below the domestic price, which group in the home country loses?
7. (HL only) Country J makes 12 shirts or 4 machines. Country K makes 10 shirts or 5 machines. Find the opportunity cost of a machine in each country.
8. (HL only) Which country has the comparative advantage in machines, and which in shirts?
9. (HL only) Give the range of terms of trade (shirts per machine) at which both countries gain.
10. (HL only) State two limitations of the theory of comparative advantage.

Answers

1. Sales are not limited by the home population, so output can rise, fixed costs are spread and profit can grow.
2. (90 000 + 3 × 10 000) ÷ 10 000 = 12. (90 000 + 3 × 30 000) ÷ 30 000 = 6.
3. 120 = 5P, so P = 24, Q = 52.
4. At 30: Qd = 40, Qs = 70, so exports = 30. Revenue = 30 × 30 = 900.
5. At 16: Qd = 68, Qs = 28, so imports = 40. Expenditure = 16 × 40 = 640.
6. Domestic producers, who receive a lower price and sell less.
7. J: 12 ÷ 4 = 3 shirts. K: 10 ÷ 5 = 2 shirts.
8. K in machines (2 < 3). J in shirts (⅓ machine < ½ machine).
9. Between 2 and 3 shirts per machine.
10. For example: constant opportunity cost is assumed, and transport costs are ignored.

Where marks are usually lost

• Using the domestic equilibrium price instead of Pw when finding revenue or expenditure.
• Subtracting quantities the wrong way round and giving a negative export figure.
• Dividing the wrong way when finding opportunity cost.
• Arguing that a country that is better at both goods gains nothing from trade.
• Drawing the world price as a curve, or leaving the axes, curves or Pw unlabelled.
• Listing benefits with no mechanism, so the answer stays at description when the command term asks for explanation.
• Giving only gains and no losers when asked to evaluate or discuss.
• Listing limitations of the theory without saying how serious each one is, which leaves the answer without a judgement.
• Showing only a final number in a calculation. The guide’s meaning of calculate requires the stages of working.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published by the International Baccalaureate Organization in February 2020. This page covers sub-topic 4.1 of Unit 4, The global economy.