IB DP Economics: Benefits of international trade

This study guide follows the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. It covers sub-topic 4.1, Benefits of international trade. The benefits of trade 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, and they are marked that way below.

The guide sets the benefits, diagrams and comparative advantage at analysis and skills depth (AO2, AO4) and the limitations at evaluation depth (AO3). Every figure below is invented: the countries, goods and prices are fictional.

Use it with the revision notes and the practice questions. The course page is the IB DP Economics hub, and the printable checklist lets you tick off each outcome. To find weak spots first, try the free 10-minute diagnostics.

The benefits of international trade

The guide lists nine benefits. Learn each as a short chain: cause, effect, who gains.

• Increased competition. Foreign sellers enter the home market. Domestic firms that were sheltered must cut costs, improve quality or lose customers.
• Lower prices. More supply and more competition push prices down. Consumers can buy more for the same income.
• Greater choice. Households can buy varieties that the home economy cannot make, or cannot make cheaply. Firms also get a wider choice of inputs.
• Acquisition of resources. A country can obtain raw materials, energy, machinery or technology that it lacks. A country with no oil reserves, for example, can still run vehicles.
• More foreign exchange earnings. Exports bring in foreign currency. That currency pays for imports and for debts owed abroad.
• Access to larger markets. A firm is no longer limited by the size of its home population. Exporting raises sales and can raise profit.
• Economies of scale. A larger market allows higher output, and the average cost of each unit can fall. This links to the previous point.
• More efficient resource allocation. Resources move from activities where the country is weak towards those where it is strong. The same resources then produce more of what people value.
• More efficient production. Competition and specialisation push firms to use better methods, so less input is wasted per unit.

Worked example: economies of scale

Fictional firm Dalmora Tiles has fixed costs of 240 000 currency units a month and variable costs of 5 per tile.

Selling only at home, it makes 20 000 tiles.

Average cost = (240 000 + 5 × 20 000) ÷ 20 000 = 340 000 ÷ 20 000 = 17 per tile.

After it starts to export, output is 60 000 tiles.

Average cost = (240 000 + 5 × 60 000) ÷ 60 000 = 540 000 ÷ 60 000 = 9 per tile.

Average cost falls by 8, which is 47.1% of the old figure. The fixed cost is spread over three times as many tiles. The firm can now cut its price abroad and still earn a margin.

Free trade when the world price is above the domestic price

Build the diagram in this order. Put price on the vertical axis and quantity on the horizontal axis. Draw the domestic demand curve (D) and domestic supply curve (S). Mark the no-trade equilibrium where they cross, at price P and quantity Q. Draw a horizontal line at the world price, Pw. Under free trade, domestic buyers and sellers face this price, because any firm can sell abroad at Pw.

If Pw is above P, the country can make this good more cheaply than the rest of the world. At Pw domestic sellers want to supply more than domestic buyers want to buy, so the difference is exported.

Where the Pw line meets D, read off the quantity demanded (Qd). Where it meets S, read off the quantity supplied (Qs). The horizontal gap, Qs − Qd, is the quantity of exports. The effects:

• Domestic consumers pay more, so consumer surplus falls.
• Domestic producers receive more and sell more, so producer surplus rises.
• The producer gain is larger than the consumer loss, so the country gains overall.

Worked example: exports (HL only calculation)

Fictional market for ceramic tiles in Dalmora. Demand is Qd = 120 − 2P and supply is Qs = 2P − 20, with price in currency units and quantity in thousands of tiles.

1. No-trade equilibrium: 120 − 2P = 2P − 20, so 140 = 4P, P = 35 and Q = 50.
2. The world price is 40. At 40, Qd = 120 − 80 = 40 and Qs = 80 − 20 = 60.
3. Exports = 60 − 40 = 20 thousand tiles.
4. Export revenue = 40 × 20 = 800 thousand currency units.

For the welfare change, find the price at which each curve meets the axis. Demand reaches zero at P = 60. Supply reaches zero at P = 10.

	Before trade	Free trade	Change
Consumer surplus	½ × 50 × (60 − 35) = 625	½ × 40 × (60 − 40) = 400	−225
Producer surplus	½ × 50 × (35 − 10) = 625	½ × 60 × (40 − 10) = 900	+275
Total	1 250	1 300	+50

You can check the net gain as one triangle: ½ × (40 − 35) × 20 = 50.

Free trade when the world price is below the domestic price

Use the same axes and curves, but now Pw lies below P. At Pw domestic buyers want more than domestic sellers will supply. The shortage is filled by imports, so the country imports Qd − Qs.

• Consumers pay less and buy more, so consumer surplus rises.
• Domestic producers receive less and produce less, so producer surplus falls.
• The consumer gain is larger than the producer loss, so there is a net gain.

The gain is real but unevenly shared. Domestic producers and their workers lose, and a high-scoring answer says so rather than claiming that everyone benefits.

Worked example: imports (HL only calculation)

Fictional market for cooking oil in Veshtar. Demand is Qd = 200 − 4P and supply is Qs = 2P − 10, with quantity in thousands of litres.

1. No-trade equilibrium: 200 − 4P = 2P − 10, so 210 = 6P, P = 35 and Q = 60.
2. World price is 20. Qd = 200 − 80 = 120 and Qs = 40 − 10 = 30.
3. Imports = 120 − 30 = 90 thousand litres.
4. Import expenditure = 20 × 90 = 1 800 thousand currency units.

Consumer surplus rises from ½ × 60 × (50 − 35) = 450 to ½ × 120 × (50 − 20) = 1 800, a gain of 1 350. Producer surplus falls from ½ × 60 × (35 − 5) = 900 to ½ × 30 × (20 − 5) = 225, a loss of 675. The net gain is 675, which equals ½ × (35 − 20) × 90.

Absolute and comparative advantage (HL only)

A country has absolute advantage in a good when it makes the good with fewer resources than a trading partner, or gets more output from the same resources. It has comparative advantage when making the good costs it a smaller sacrifice of other goods than it costs the partner, so its opportunity cost is lower.

Absolute advantage compares output. Comparative advantage compares opportunity cost. A country can be better at everything and still have a comparative advantage in only some goods, because it cannot have the lowest opportunity cost in both goods in a two-good model.

Calculating opportunity cost

Opportunity cost of good X in terms of good Y = amount of Y given up ÷ amount of X gained.

Fictional data: with all its resources for a month, Arvenia can make 120 tonnes of dried fruit or 60 thousand tiles. Kestria can make 100 tonnes of fruit or 20 thousand tiles.

	Fruit only	Tiles only	Opportunity cost of 1 thousand tiles	Opportunity cost of 1 tonne of fruit
Arvenia	120 t	60 thousand	120 ÷ 60 = 2 t of fruit	60 ÷ 120 = 0.5 thousand tiles
Kestria	100 t	20 thousand	100 ÷ 20 = 5 t of fruit	20 ÷ 100 = 0.2 thousand tiles

Arvenia has an absolute advantage in both goods, since 120 > 100 and 60 > 20. But Arvenia has the lower opportunity cost of tiles (2 against 5), so its comparative advantage is in tiles. Kestria has the lower opportunity cost of fruit (0.2 against 0.5), so its comparative advantage is in fruit.

The PPC diagram and the gains from trade

Put fruit up the side and tiles along the bottom. Each country’s PPC is a straight line, because the opportunity cost is constant. Arvenia’s line runs from 120 on the fruit axis to 60 on the tile axis, so it is shallow. Kestria’s runs from 100 to 20, so it is steeper. Different slopes mean different opportunity costs, and that difference creates the gain.

Suppose each country first produces and consumes on its own PPC:

• Arvenia: 40 t fruit and 40 thousand tiles. Check: 120 − 2 × 40 = 40, so the point is on the line.
• Kestria: 60 t fruit and 8 thousand tiles. Check: 100 − 5 × 8 = 60.
• World output: 100 t of fruit and 48 thousand tiles.

Now each specialises in its comparative-advantage good: Arvenia makes 60 thousand tiles and Kestria makes 100 t of fruit. World output is 100 t of fruit and 60 thousand tiles. There is the same fruit and 12 thousand more tiles.

The countries agree to trade at 4 t of fruit per thousand tiles. This lies between the two opportunity costs, 2 and 5, which is the range in which both gain. Kestria buys 10 thousand tiles for 40 t of fruit.

	Tiles	Fruit	Change from before trade
Arvenia	60 − 10 = 50	40	+10 thousand tiles
Kestria	10	100 − 40 = 60	+2 thousand tiles

Both countries consume outside their own PPC. The nearer the terms are to Kestria’s cost of 5, the more Arvenia gains, and the nearer they are to 2, the more Kestria gains. Outside the 2 to 5 range one country would do better at home.

Sources of comparative advantage

• Factor endowments: land, climate, minerals, labour supply and capital stock.
• Technology and know-how that make labour or capital more productive.
• Education and skills of the workforce.
• Quality of infrastructure and institutions, and past investment.

Comparative advantage can change: investment in skills and technology can lower a country’s opportunity cost in a good.

Limitations of the theory of comparative advantage (HL only)

The guide places this at an evaluation depth, so a list is not enough. For each limitation, say what the theory assumes, how real life differs and how serious the gap is.

• Constant opportunity cost. Straight-line PPCs assume it. In practice, moving resources into one good often raises the cost of each extra unit.
• Transport and other trade costs. The model ignores them. They can erase a small gain.
• Full employment and mobile resources. Workers made redundant in the import-competing industry may stay unemployed if they lack the skills for the growing one.
• Over-specialisation. Reliance on one export means a price drop or a shift in foreign demand hits the whole economy.
• Economies of scale and imperfect competition. The model assumes perfect competition, but real trade often involves a few large firms.
• Unequal distribution of gains. The country gains overall, but particular groups lose.
• Non-economic costs. Environmental damage is not counted.

A balanced evaluation says that the theory shows why trade can raise output, while its assumptions mean the gains in practice are smaller and less evenly spread than the model suggests.

Common errors

• Assuming the most productive country gains nothing from trade. It still gains, because it has a comparative advantage in something.
• Dividing the wrong way round. Opportunity cost of X is units of Y given up per unit of X, so check which good sits in the denominator.
• Drawing the world price as a sloping line. It is horizontal for a small economy that takes the world price as given.
• Reading exports from the wrong side. Exports are Qs − Qd. Imports are Qd − Qs.
• Calculating revenue or expenditure with the domestic price rather than Pw.
• Forgetting that trade creates losers, which leaves the evaluation one-sided.

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. See also the IB DP Economics syllabus guide.