OxfordAQA International AS and A-level Economics: International trade (9640) – Revision Notes

These notes condense section 3.4.1.2 (Trade) of the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. Section 3.4 belongs to the extra International A2 part of the course. The study guide has the full explanations, so start there, then test yourself with the practice questions. Course pages: the OxfordAQA A-level Economics hub and the checklist. A free 10-minute diagnostic shows what to revise first. Every number below is made up.

Key definitions

Term	Meaning
Absolute advantage	Can produce a good using fewer resources than another country
Comparative advantage	Lower opportunity cost of a good than another country
Opportunity cost (in trade)	Amount of the alternative good sacrificed when output of this one rises by a unit
Specialisation	Concentrating production on the goods with the lowest opportunity cost
Terms of trade	Ratio of export prices to import prices, shown as an index
Protectionism	Government measures that make imports less competitive against home-made goods
Tariff	Tax on imports
Quota	Limit on the quantity of imports
Export subsidy	Payment to firms for each unit they export
Dumping	Selling abroad at a price below cost, or below the price at home
Infant industry	A new industry that needs time to build scale and skills

Formulas and rules

Item	Rule
Cost of one unit of X, measured in Y	Maximum output of Y ÷ maximum output of X
Comparative advantage	The country with the lower opportunity cost
Mutually beneficial terms	Price of a unit lies strictly between the two countries’ opportunity costs
Terms of trade	(export price index ÷ import price index) × 100
Percentage change	(new − old) ÷ old × 100
Exports needed for the same imports	100 ÷ terms of trade index
Tariff revenue	Tariff per unit × imports after the tariff
Quota rent	(Domestic price − world price) × quota
Ad valorem tariff	Percentage of the import price

Method 1: find comparative advantage

1. Write the maximum output of each good for each country.
2. Work out the opportunity cost of one unit of one good in each country (divide the other good’s output by it).
3. The country with the lower figure has the comparative advantage in that good. The other country has it in the second good.
4. State the range of terms of trade where both gain.

Reminder (invented). In a month, Country C makes 90 chairs or 30 lamps, and Country D makes 40 chairs or 20 lamps.

• One lamp costs C 90 ÷ 30 = 3 chairs and costs D 40 ÷ 20 = 2 chairs. D has the comparative advantage in lamps.
• One chair costs C 30 ÷ 90 = 1/3 lamp and costs D 20 ÷ 40 = 1/2 lamp. C has the comparative advantage in chairs.
• C is better at both (90 > 40 and 30 > 20), but it still gains by specialising in chairs.
• Both gain if one lamp trades for between 2 and 3 chairs.

Method 2: terms of trade

1. Put the export price index on top and the import price index below.
2. Multiply by 100.
3. Above 100 means improved, below 100 means deteriorated, and the comparison is always with the base year.

Reminder. Exports 132, imports 110: 132 ÷ 110 × 100 = 120, an improvement. If the terms of trade then fall from 120 to 96, the change is (96 − 120) ÷ 120 × 100 = −20%. At 96, against a base of 100, a country needs 100 ÷ 96 = 1.042 times as many exports as in the base year for the same imports, about 4.2% more.

Causes: changes in commodity prices, the exchange rate, relative inflation, world demand, tariffs and other barriers.

Effects: an improvement lets each export buy more imports. The effect on the trade balance depends on how responsive volumes are to price, so it is never automatic.

Method 3: tariffs, quotas and export subsidies

Use the same sequence for each:

1. Find the free-trade price (the world price for a small country), quantity demanded, quantity supplied and imports.
2. Apply the policy and find the new price and quantities.
3. Calculate changes in consumer surplus, producer surplus and government revenue.
4. Find the net welfare loss, which equals the two triangles.

Policy	Price at home	Imports	Who gains	Who loses
Tariff	Rises by the tariff	Fall	Domestic producers and government	Consumers
Quota	Rises until demand minus supply equals the quota	Fixed at the quota	Domestic producers and licence holders	Consumers
Export subsidy	Rises to world price plus subsidy	No direct change; exports rise	Producers	Consumers and taxpayers

Reminder. A 12% ad valorem tariff on an import priced at 250 adds 250 × 0.12 = 30. A tariff of 3 on 40 units of imports brings revenue of 120. A subsidy of 3 per unit on 50 exported units costs 150.

Reasons for and against protection

Reason given	Weakness to raise
Infant industry	Hard to pick winners; protection can last for ever
Declining industry and jobs	Delays adjustment and raises prices for everyone
National or food security	Stockpiles or other policies may cost less
Dumping	Hard to prove; consumers gain from the low price
Revenue	Reduces trade, so revenue may fall short
Narrow economy	Other policies may do more

Must-know distinctions

• Absolute advantage compares outputs. Comparative advantage compares opportunity costs.
• A tariff raises revenue for the government. A quota creates a gain for licence holders unless licences are sold.
• A higher terms of trade index does not by itself mean a stronger current account.
• Free trade area: no internal barriers. Customs union adds a common external tariff. Common market adds free movement of labour and capital. Monetary union adds a single currency.

Evaluation chains

• Tariff: price rises, consumers buy less, domestic firms supply more, imports fall, government gains revenue. But other countries may retaliate, firms using imported inputs face higher costs, and the long-run effect on competitiveness may be negative.
• Infant industry: protect now, firm gains scale and learns, costs fall, protection removed. This works only if protection is temporary and the industry could really become competitive.
• Costs of trade: an industry shrinks, workers lose jobs, retraining is slow, so unemployment lasts. The cost is lower if labour is mobile and the economy is diverse.
• Comparative advantage changes: wages rise or new skills develop, costs shift, and the pattern of trade changes. A policy based on today’s advantage may look wrong later.
• Bloc: members trade more with each other. This can raise efficiency, but if a cheaper non-member is shut out the gain is smaller.
• WTO: lowers barriers and settles disputes, but relies on members accepting its decisions, and it is slow to reach agreements.

Quick self-test

1. In a month, Country C makes 90 chairs or 30 lamps. Country D makes 40 chairs or 20 lamps. Which country has the comparative advantage in lamps?
2. State the range of terms (chairs per lamp) at which both countries gain.
3. Export prices index 132 and import prices index 110. Calculate the terms of trade.
4. Export price index 120 and terms of trade 96. Find the import price index.
5. Terms of trade fall to 85. By what percentage must export volume rise to buy the same imports? Give one decimal place.
6. A 15% ad valorem tariff is placed on an import costing 40. What is the new price?
7. A quota of 40 units lifts the home price 3 above the world price. Calculate the quota rent.
8. Which bloc type applies a shared tariff to outsiders yet still restricts the movement of workers between members?
9. State two roles of the WTO.
10. Give two reasons why a country’s comparative advantage might change.
11. Define dumping.
12. A subsidy of 3 per unit is paid on 50 exported units. What does it cost the government?

Answers

1. Country D (opportunity cost 2 chairs against 3 chairs).
2. Between 2 and 3 chairs per lamp.
3. 132 ÷ 110 × 100 = 120.
4. Import index = 120 ÷ 96 × 100 = 125.
5. 100 ÷ 85 = 1.176, so about 17.6%.
6. 40 × 1.15 = 46.
7. 3 × 40 = 120.
8. A customs union.
9. Any two of: forum for negotiating lower trade barriers, monitoring members’ trade policies, settling disputes, administering agreements.
10. Any two of: investment in education or capital, new technology, discovery or exhaustion of resources, wage changes, exchange rate changes.
11. Selling in a foreign market at a price below cost, or below the price charged at home.
12. 3 × 50 = 150.

Where marks are usually lost

• Using total output instead of opportunity cost to find comparative advantage.
• Giving a range of terms of trade that includes the opportunity costs themselves.
• Dividing the wrong way round when finding opportunity cost or the terms of trade.
• Stating that a tariff “makes imports cheaper” or that quotas raise government revenue.
• Leaving out the welfare triangles when asked for the net effect of a tariff.
• Listing reasons for protection without any evaluation of whether it works.
• Giving a one-sided answer on trading blocs with no mention of costs or non-members.
• Saying “terms of trade improved” without saying whether the index rose or fell against a base year.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, first teaching September 2020, first International AS exams May/June 2021, first International A-level exams May/June 2022; section 3.4.1.2 Trade.