OCR A Level Economics: Trade, comparative advantage and the terms of trade (H460) – Revision Notes

These notes condense the topic International trade from Component 2, Macroeconomics, of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. All of the specification is A Level. For full explanations read the study guide, then test yourself with the practice set. Course pages: the hub, the checklist and the free diagnostics. Opportunity cost and the PPF are in the opportunity cost guide, and productivity and ULC in the labour demand guide. All figures here are invented.

Definitions

Term	Meaning
International trade	Exchange of goods and services across borders
Absolute advantage	Fewer resources per unit, or more output from the same resources
Comparative advantage	Giving up less of other goods to make a good
Terms of trade	How many imports one unit of exports buys, as a price ratio
Heckscher-Ohlin	Countries export goods that use their abundant factor intensively
International competitiveness	Ability to sell against foreign rivals at home and abroad
Aid	Transfer of resources from donors to recipients

Formulas

Measure	Formula
Opportunity cost of good X	Units of Y given up / units of X gained
Opportunity cost from hours	Hours per unit of X / hours per unit of Y (in units of Y)
Terms of trade index	Export price index divided by import price index, times 100
Unit labour cost	Labour cost / output, or wage per worker / output per worker
Change in ULC	(1 + wage growth) / (1 + productivity growth) - 1
Foreign price of an export	Domestic price x exchange rate (foreign units per domestic unit)

Method: opportunity cost ratios

1. Write each country’s cost of one unit of good X in terms of Y.
2. The lower figure shows the comparative advantage in X. The other country has it in Y.
3. The mutually beneficial terms lie between the two opportunity costs.
4. Compare consumption with and without trade.

Worked reminder. Country F needs 5 hours for a unit of A and 10 for a unit of B. Country G needs 8 and 12. F has an absolute advantage in both (fewer hours).

	1 unit of A costs	1 unit of B costs
Country F	5/10 = 0.5 B	10/5 = 2 A
Country G	8/12 = 0.67 B	12/8 = 1.5 A

F has the comparative advantage in A (0.5 is below 0.67). G has it in B (1.5 is below 2). One unit of A should trade for between 0.5 and 0.67 units of B. Equivalently, one unit of B trades for between 1.5 and 2 units of A.

Method: gains from trade

• Fix a no-trade point on each frontier and total the world output.
• Move each country towards its comparative advantage good.
• Pick terms inside the range. The exports of one country equal the imports of the other.
• State the extra consumption each country gets. A gain exists only if the terms lie inside the range.

Terms of trade

• Rise in the index: improvement; each unit of exports buys more imports.
• Fall: deterioration; fewer imports per unit of exports.

Worked reminder. Country L has export prices of 108 and import prices of 96 (base 100). Terms of trade = 108 / 96 x 100 = 112.5, an improvement of 12.5%. If instead export prices were 96 and import prices 120, the index would be 96 / 120 x 100 = 80.0, a deterioration of 20%.

Determinants: world demand and supply of the goods; income and price elasticities; exchange rate; relative inflation and productivity; market power; subsidies and trade barriers.

Evaluation reminder. Suppose export prices rise 8% and PED for the exports is -2. Volume falls 16%, so revenue is 1.08 x 0.84 = 0.9072 of its old level, a fall of 9.3%. An improvement in the terms of trade can therefore reduce export revenue when demand is elastic. It helps most when demand for exports is inelastic, or when import prices fall.

Heckscher-Ohlin in steps:

1. Identify the abundant and scarce factor in each country.
2. The country exports goods using its abundant factor intensively and imports the others.
3. Factor prices tend to move closer together as trade grows.

Assumptions: same technology, similar tastes, perfect competition, no transport costs, factors that move within but not between countries. Weakness: it ignores technology, skills and economies of scale, and it cannot explain much trade between similar countries. For the terms of trade, a country whose abundant factor supports only primary goods faces volatile prices and weak income elasticity.

The changing pattern of global trade

• Emerging economies have a larger share of world exports.
• Manufactures and services have grown relative to primary products.
• Global value chains split production across countries.
• Intra-industry trade among similar economies has grown.
• Causes: lower transport and communication costs, liberalisation, multinational firms, rising incomes, technology.

Evaluating comparative advantage

For	Against
Shows why trade raises output even when one country is better at everything	Opportunity costs rise, so specialisation is partial
Explains much resource-based trade	Cannot explain much intra-industry trade (differentiation, scale)
Simple and logical	Static: ignores dynamic comparative advantage
	Overspecialisation brings exposure to shocks and structural unemployment
	Assumes full employment, no transport cost, no externalities

Judgement: strong for resource-based trade, weaker for differentiated manufactures and services. A good conclusion says which assumption matters most for the case in the question, such as rising opportunity costs for a large economy or price volatility for a commodity exporter.

International competitiveness

• Productivity, unit labour costs, exchange rate, quality and non-price factors, infrastructure, tax.
• Worked reminder. Wages rise 5% and productivity 3%: ULC changes by 1.05 / 1.03 - 1 = +1.94%. Add a 2% appreciation and the ULC in foreign currency rises by 1.0194 x 1.02 - 1 = +3.98%.
• An export priced at 300 domestic units, with 0.40 foreign units per domestic unit, costs 120 abroad. After a 5% appreciation (0.42) it costs 126.
• Evaluation: price matters more in elastic markets; quality and brand can offset high costs. Low wages can reflect low productivity, so compare ULC, not wages. A government can raise competitiveness through education, infrastructure and investment, but results take years.

Trade and aid

Economy	Gains from trade	Costs of trade
Developed	Lower prices, variety, competition	Job losses in declining sectors, inequality
Emerging	Export-led growth, investment	Dependence on foreign demand, pollution
Developing	Market access, foreign exchange	Commodity dependence, price volatility

Aid: finances investment, health and education, and relief; but risks dependency, corruption, tied aid and debt. Forms include grants, concessional loans, technical help, emergency relief, bilateral aid from one donor and multilateral aid through an institution. Judge by type, governance, size and whether it builds productive capacity.

Must-know distinctions

• Absolute advantage (fewer resources) versus comparative advantage (lower opportunity cost).
• Terms of trade (a price ratio) versus trade balance (a money value).
• Improvement in the terms of trade versus an improvement in competitiveness.
• Productivity (output per worker) versus ULC (cost per unit of output).

Quick self-test

1. State what comparative advantage means.
2. Country F needs 5 hours per unit of A and 10 per unit of B; Country G needs 8 and 12. Which has the comparative advantage in A?
3. Within what range of units of B per unit of A would trade benefit both?
4. Export prices are 105 and import prices 90. Calculate the terms of trade.
5. Export prices are 96 and import prices 120. What does the index show?
6. Wages rise 4% and productivity 1%. What is the change in ULC?
7. A country has abundant skilled labour. What does Heckscher-Ohlin predict it exports?
8. Give two determinants of the terms of trade.
9. Why does comparative advantage struggle to explain intra-industry trade?
10. An export costs 400 domestic units at 0.50 foreign units per domestic unit. What is the foreign price after a 5% appreciation?
11. Give one disadvantage of tied aid.

Answers

1. Giving up fewer other goods than a rival country does to make a good.
2. F: 0.5 B against G’s 0.67 B.
3. Between 0.5 and 0.67 units of B.
4. 105 / 90 x 100 = 116.7.
5. 96 / 120 x 100 = 80.0, a deterioration: each export buys 20% fewer imports.
6. 1.04 / 1.01 - 1 = +2.97%.
7. Goods that use skilled labour intensively.
8. For example world demand and the exchange rate.
9. Countries trade similar differentiated products, driven by variety and scale economies, not differences in opportunity cost.
10. 400 x 0.525 = 210 (from 200).
11. It benefits the donor’s firms and may raise costs or reduce the recipient’s choice.

Where marks are usually lost

• Naming the country with higher output as having comparative advantage.
• Inverting the opportunity cost fraction.
• Quoting terms of trade outside the beneficial range.
• Calling any rise in the terms of trade good, with no mention of elasticity.
• Describing the pattern of trade with no cause.
• Judging competitiveness from wages alone.
• Listing the assumptions of comparative advantage but not saying which matter most.
• Concluding on aid without distinguishing types or recipients.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021. Component 2, Macroeconomics: area of study The global context, topic International trade.