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

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers International trade, part of The global context in Component 2, Macroeconomics. The specification labels no content as AS or Extension: all of it is A Level. Every country and figure is made up for illustration.

Other units cover globalisation, the balance of payments, exchange rates, protectionism and integration. Use the OCR Economics hub, the checklist and the free diagnostics to plan your revision. Opportunity cost and the PPF are taught in the opportunity cost and specialisation guide. Pair this guide with the revision notes and the practice set.

What this unit covers

Outcome in the specification	Section below
Explain international trade	1
Explain and distinguish absolute and comparative advantage	2
Calculate opportunity cost ratios to illustrate gains from trade	3
Explain and calculate the terms of trade	4
Explain what determines the terms of trade, including Heckscher-Ohlin	5
Explain how the pattern of global trade has changed	6
Evaluate comparative advantage as an explanation of trade patterns	7
Explain how countries achieve international competitiveness	8
Evaluate the advantages and disadvantages of trade and aid	9

1. International trade

International trade is the exchange of goods and services across national borders. Exports are sold abroad; imports are bought from abroad. Countries trade because specialising raises output and buyers want variety and lower prices.

2. Absolute and comparative advantage

Absolute advantage: a country can produce a good using fewer resources per unit than another country, or produce more of it from the same resources.

Comparative advantage: a country gives up less of other output to make a good than a rival does, whatever its absolute productivity.

A country can have an absolute advantage in everything yet a comparative advantage in only some goods, because opportunity cost is relative. So a less productive country still gains from trade.

3. Opportunity cost ratios and the gains from trade

Method:

1. Find the opportunity cost of one unit of each good in each country.
2. Compare. The lower opportunity cost shows the comparative advantage.
3. Find the range of terms that benefit both countries.
4. Show output and consumption before and after specialisation and trade.

Worked example. Country A and Country B each have a fixed workforce. Using all its resources for one good, Country A makes 80 tonnes of coffee or 60 thousand toys. Country B makes 30 tonnes of coffee or 15 thousand toys. Both can switch resources at constant cost.

Absolute advantage: A is better at both (80 is above 30; 60 is above 15).

Opportunity costs:

	1 tonne of coffee costs	1 thousand toys costs
Country A	60/80 = 0.75 thousand toys	80/60 = 1.33 tonnes of coffee
Country B	15/30 = 0.5 thousand toys	30/15 = 2 tonnes of coffee

B gives up less toys per tonne of coffee, so B has the comparative advantage in coffee. A gives up less coffee per thousand toys, so A has it in toys.

Range of mutually beneficial terms. One tonne of coffee must trade for between 0.5 thousand toys (B’s cost) and 0.75 thousand toys (A’s cost). Outside it one country does better producing the good itself: at 0.8 thousand toys per tonne, A would make coffee at home for 0.75.

Before trade (each on its frontier): A makes 32 tonnes of coffee and 36 thousand toys (40% and 60% of its resources). B makes 12 tonnes and 9 thousand toys (40% and 60%). World output is 44 tonnes of coffee and 45 thousand toys.

After specialisation: B makes only coffee, 30 tonnes. A puts 25% of resources into coffee, giving 20 tonnes, and 75% into toys, giving 45 thousand. World output is 50 tonnes and 45 thousand toys, so world coffee is 6 tonnes higher with no loss of toys.

Trade at 0.6 thousand toys per tonne of coffee (inside the range). B needs 9 thousand toys, so A exports 9 thousand toys and receives 9 / 0.6 = 15 tonnes of coffee.

	Coffee	Toys	Change
Country A consumes	20 + 15 = 35	36	+3 tonnes coffee
Country B consumes	30 - 15 = 15	9	+3 tonnes coffee

The 6 extra tonnes of coffee are shared 3 and 3. The nearer the terms are to a country’s own opportunity cost, the smaller its share.

Using labour hours. If Country C needs 4 hours for a unit of steel and 6 for a unit of furniture, and Country D needs 10 and 12, then C’s opportunity cost of steel is 4/6 = 0.67 furniture and D’s is 10/12 = 0.83. C’s comparative advantage is steel. D’s is furniture (1.2 steel against C’s 1.5).

4. The terms of trade

The terms of trade show how many imports a country gets for its exports. The index divides the export price index by the import price index and multiplies by 100:

Terms of trade = (export prices / import prices) x 100

A rise is an improvement: each unit of exports buys more imports. A fall is a deterioration.

Worked example. In Country K (illustrative), with the base year at 100, export prices are 112 and import prices 125.

Terms of trade = 112 / 125 x 100 = 89.6. This is a deterioration of 10.4%. Exports of 500 units would have bought 500 units of imports in the base year; they now buy 500 x 0.896 = 448 units. If export prices were 120 and import prices 100, the index would be 120, an improvement.

Evaluation. An improvement is not automatically good. If export prices rise 10% and demand is price elastic (PED of -1.5), export volume falls 15%. Export revenue is then 1.10 x 0.85 = 0.935 of the old level, a 6.5% fall. A deterioration can raise export volumes. The index also hides which products moved.

5. What determines the terms of trade

• Demand and supply for the goods traded. Strong world demand for a country’s exports raises their price.
• Elasticities. Primary products often have low income elasticity of demand, so rising world incomes lift demand for them slowly, while manufactures and services often have higher income elasticity. Low price elasticity of supply makes primary prices volatile.
• Exchange rate. Prices of exports and imports are compared in a common currency, so a currency change alters the index when prices are set in foreign currency.
• Relative inflation and productivity. Rapid productivity growth lowers costs and export prices; high domestic inflation raises them.
• Market power. A producer or group with market power can hold prices up; buyers with market power can push them down.
• Trade barriers and subsidies change prices.

Heckscher-Ohlin theory. A country has a comparative advantage in goods that use intensively the factor in which it is abundant, and imports goods that use its scarce factor intensively.

	Country M	Country N
Abundant factor	Land	Capital
Scarce factor	Capital	Land
Exports	Land-intensive goods	Capital-intensive goods

Abundance makes the factor cheap, so goods using it are cheap to produce. The theory assumes similar technology and tastes, perfect competition, no transport costs and factors that move within but not between countries. It predicts that trade narrows differences in factor prices. Some tests fit poorly, and the model leaves out technology, skills and economies of scale. For the terms of trade, a country whose abundant factor supports only primary goods is exposed to falling or volatile prices.

6. The changing pattern of global trade

Describe changes in general terms and give reasons:

• Emerging economies, especially in Asia, have taken a rising share of world exports, while the share of long-established industrial economies has fallen.
• Manufactures have grown relative to primary products, and trade in services has grown quickly.
• Falling transport and communication costs, trade liberalisation and multinational firms have created global value chains, where parts are made in several countries before final assembly.
• Intra-industry trade, such as countries exporting and importing cars, has grown among similar economies, and trade among developing and emerging economies has grown.

Link each trend to a cause, such as factor endowments, rising incomes, technology or policy.

7. Evaluating comparative advantage as an explanation of trade patterns

Strengths. It shows why trade raises output even when one country is more productive at everything.

Limitations:

• Opportunity costs usually rise as a country specialises, so specialisation is partial, not complete.
• Much trade is between similar countries in similar goods, which comes from product differentiation and economies of scale, not from differences in opportunity cost.
• Advantage changes over time. A country can build dynamic comparative advantage through education, investment and technology. A static model misses this.
• Specialisation leaves a country exposed to demand and price shocks, and workers in declining sectors may face structural unemployment.
• It assumes full employment, mobile resources, no transport costs or barriers and no externalities, and multinational firms and government policy also shape where production happens.

Judgement. It explains the direction of much trade, particularly in resource-based goods, but is a weaker guide to trade in differentiated manufactures and services.

8. International competitiveness

A country or firm is internationally competitive if it can sell goods and services abroad and at home against foreign rivals.

• Productivity (output per worker or per hour) lowers cost per unit. Training, investment, technology and infrastructure raise it.
• Unit labour costs (ULC) = labour cost / output, or the wage per worker / output per worker. A wage rise is offset if productivity rises by as much.
• Exchange rates. An appreciation raises the foreign price of exports and lowers the domestic price of imports. A depreciation does the opposite.
• Product quality and non-price factors: design, reliability, branding, delivery and after-sales service.
• Other factors: infrastructure, energy costs, tax and regulation.

Worked example. In Country X the average wage is 30,000 and output per worker is 50,000, so ULC = 30,000 / 50,000 = 0.60. A year later wages rise 6% and productivity 3%. ULC rises by 1.06 / 1.03 - 1 = 2.91%. In Country W, wages rise 2% and productivity 5%, so ULC changes by 1.02 / 1.05 - 1 = -2.86%. If X’s currency also appreciates 4% against W’s, X’s ULC in W’s currency has risen 1.0291 x 1.04 - 1 = 7.03%. X’s costs are now 1.0703 / 0.9714 = 1.102 times W’s relative to a year ago, so X is about 10.2% less cost competitive.

Exchange-rate example: a machine costs 200 units of X’s currency and each unit buys 0.50 of the foreign currency, so the foreign price is 100. After a 10% appreciation (0.55), the foreign price is 110.

Evaluation: cost competitiveness matters most in price-elastic markets. Strong quality and brands can compete despite high ULC, and low wages can reflect low productivity.

9. Advantages and disadvantages of trade and aid

	Trade: advantages	Trade: disadvantages
Developed	Lower prices, variety, competition, scale economies	Job losses in declining industries, inequality, offshoring
Emerging	Export-led growth, investment, technology	Dependence on foreign demand, environmental pressure, inequality
Developing	Market access, foreign exchange, new technology	Commodity dependence, volatile prices, weak infant industries

Aid is a transfer of resources, such as grants, concessional loans, technical help or emergency relief, from donors to recipients.

• Advantages: finances investment where domestic saving is low, provides health, education and infrastructure, and eases crises.
• Disadvantages: dependency, corruption, tied aid that benefits donors, debt from loans, and local markets distorted by free goods.

Evaluation. Gains depend on the type of aid, governance, size relative to the economy and whether it supports lasting productive capacity. Trade often brings larger flows than aid, but poor countries may lack the capacity to use it. In developed economies the costs of trade fall on particular regions and groups.

Common errors

• Choosing comparative advantage by larger output, not lower opportunity cost.
• Dividing the wrong way round when finding an opportunity cost.
• Using terms outside the range between the two opportunity costs.
• Treating a rise in the terms of trade index as always good.

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.