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

This guide is written for the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. It covers section 3.4.1.2 (Trade). Section 3.4 belongs to the extra International A2 part of the course and builds on the International AS sections 3.1 and 3.2. Section 3.5 (quantitative skills) can be assessed in any unit, so the sums here use percentages (QS2), index numbers (QS5), graphs (QS4) and reading data (QS9). No real country or statistic is used: all figures are made up. Globalisation and transnational corporations (3.4.1.1) are taught on a different page, so they are left out here.

Use it with the revision notes and the practice questions. Course pages: the OxfordAQA A-level Economics hub and the checklist. A free 10-minute diagnostic shows where to start. For specialisation within a single economy, see production, productivity, specialisation and exchange.

What the specification asks for

Specification content	Where it is here
Model of comparative advantage; absolute versus comparative advantage; total output rises	Section 1
Causes of comparative advantage and why it changes	Section 2
Other benefits of trade (economies of scale, competition); costs of trade	Section 3
Terms of trade: measurement, significance, causes and effects of changes	Section 4
Protectionist policies (tariffs, quotas, export subsidies), diagrams, reasons and consequences	Section 5
Changing pattern of world trade	Section 6
Trading blocs; role of the WTO	Section 7

1. The model of comparative advantage

A country holds an absolute advantage in a good when a given set of resources yields more of it than the same resources would abroad. It holds a comparative advantage when it sacrifices less of its other output to make one more unit. That sacrifice is the opportunity cost.

Worked example (invented). In a week, 100 workers in Country A or Country B can make either pumps or baskets.

	Pumps (all workers)	Baskets (all workers)	Opportunity cost of 1 pump	Opportunity cost of 1 basket
Country A	60	120	120 ÷ 60 = 2 baskets	60 ÷ 120 = 0.5 pump
Country B	20	100	100 ÷ 20 = 5 baskets	20 ÷ 100 = 0.2 pump

Country A has an absolute advantage in both goods (60 > 20 and 120 > 100). That does not mean it should make both. A gives up 2 baskets per pump, B gives up 5, so A has the comparative advantage in pumps. B gives up 0.2 pump per basket, A gives up 0.5, so B has the comparative advantage in baskets. It is impossible for one country to have the lower opportunity cost in both goods.

Without trade, suppose A makes 48 pumps (80% of its workers) and 24 baskets (20%), and B makes 6 pumps (30%) and 70 baskets (70%). World output is 54 pumps and 94 baskets.

With specialisation, A makes 60 pumps and B makes 100 baskets, so world output is 60 pumps and 100 baskets. That is 6 more of each, which is the sense in which specialisation and trade can raise total output.

Sharing the gain. Suppose they trade at 1 pump for 3 baskets. If A exports 9 pumps for 27 baskets, A consumes 51 pumps and 27 baskets (3 more of each than before). B consumes 9 pumps and 100 − 27 = 73 baskets (also 3 more of each).

Terms of trade matter in the model. Both countries gain only if the price of a pump lies between the two opportunity costs, here between 2 and 5 baskets. At exactly 2, A gains nothing and B takes all the gain. At exactly 5, the reverse. A price near a country’s own opportunity cost leaves it with little of the gain.

Assumptions to criticise: constant opportunity costs, no transport costs or tariffs, full employment, mobile resources within each country, and two countries and two goods. Real opportunity costs often rise as a country specialises, which limits how far specialisation is worthwhile.

2. Causes of comparative advantage and why it changes

Causes include:

• Factor endowments: land, minerals, climate, size and skills of the labour force, stock of capital.
• Productivity and technology: better methods lower the cost of a good.
• Relative costs: wage levels, energy costs, taxes, and the exchange rate.
• Economies of scale and learning: firms that start early may keep a cost lead.

It changes over time through investment in education and capital, new technology, discovery or exhaustion of resources, rising wages in a country that has grown rich, and changes in the exchange rate. A country that once made basic goods cheaply can lose that advantage as wages rise, and can gain a new one in higher-value goods. This is why a comparative advantage is not fixed, and why a policy that protects an industry today may block the shift to a better one.

3. Other benefits and costs of trade

Benefits beyond the model.

• Economies of scale: a larger market lets firms produce more, so long-run average cost falls and prices can fall.
• Competition: foreign rivals push domestic firms to cut costs and innovate, and consumers get more choice.
• Access to goods, materials and technology a country cannot make at home.

Costs.

• Structural unemployment where an industry shrinks, because workers cannot move quickly to new jobs.
• Over-specialisation leaves a country exposed to a fall in the price of its main export.
• Dependence on imports of essentials, which raises security risks.
• Environmental costs of transport and of production in places with weak rules.
• Unequal gains: owners of the expanding industries gain more than workers in the shrinking ones.

A good answer weighs these. For a large, diverse economy with flexible labour markets the costs of adjustment are lower than for a small economy that depends on one product.

4. Terms of trade

The terms of trade compare what a country earns per unit of its exports with what it pays per unit of its imports.

Terms of trade = (index of export prices ÷ index of import prices) × 100.

Worked example (Country A, invented). Year 1 is the base year.

Period	Exports (price index)	Imports (price index)	Terms of trade (index)
1	100	100	100
2	106	101	106 ÷ 101 × 100 = 104.95
3	101	110	101 ÷ 110 × 100 = 91.82
4	96	120	96 ÷ 120 × 100 = 80.0

A figure above 100 is an improvement, below 100 a deterioration. By year 4 the terms of trade have fallen by 20% on the base year. To buy the same volume of imports the country must now export 100 ÷ 80 = 1.25 times as much, 25% more.

Causes of a change. A change in the price of key exports or imports (for example a raw material), a change in the exchange rate, which moves the prices of exports and imports relative to each other, different rates of inflation, shifts in world demand or supply, and trade barriers.

Effects. An improvement lets a country buy more imports for each export, which raises real income, and it may hurt exporters if the higher prices cut sales. A deterioration reduces the living standard that a given level of exports can support. What happens to the current account depends on how responsive the volumes of exports and imports are to price (their price elasticities): a fall in export prices raises export earnings only if demand for exports is elastic. Do not assume that an improvement is always good or a deterioration always bad.

5. Protectionism

Protectionism is the use of policies to shield domestic producers from foreign competition. The specification names three.

• Tariff: a tax on imports.
• Quota: a cap on the physical amount of a good allowed in.
• Export subsidy: a payment to domestic firms for each unit exported.

Tariff and quota (invented market). Country A is a small importer of cloth and takes the world price of 5 as given. Domestic demand is Qd = 120 − 4P and domestic supply is Qs = 20 + 4P.

	Free trade	2-unit tariff
Price	5	7
Quantity demanded	100	92
Domestic supply	40	48
Imports	60	44

Diagram: price on the vertical axis, quantity on the horizontal, with the demand curve, the domestic supply curve and a horizontal line at the world price. The tariff moves that line up from 5 to 7, so demand contracts and domestic supply extends along their curves (no curve shifts). The effects are:

• Consumer surplus falls by (100 + 92) ÷ 2 × 2 = 192.
• Producer surplus rises by (40 + 48) ÷ 2 × 2 = 88.
• Government revenue is 2 × 44 = 88.
• Net welfare loss is 192 − 88 − 88 = 16, the two triangles: ½ × 2 × 8 for inefficient extra domestic production and ½ × 2 × 8 for lost consumption.

A quota of 44 units gives the same price rise, because price must reach 7 for domestic demand minus domestic supply to equal 44. The area 2 × 44 = 88 is not tax revenue. It goes to whoever holds the import licences, unless the government sells them.

Export subsidy (invented market). Country A exports tea at a world price of 10. Qd = 90 − 4P and Qs = 20 + 5P, so exports are 70 − 50 = 20. A subsidy of 2 per unit exported lifts the home price to 12, so Qd = 42 and Qs = 80, and exports rise to 38. Producers gain (70 + 80) ÷ 2 × 2 = 150, consumers lose (50 + 42) ÷ 2 × 2 = 92, and the subsidy costs 2 × 38 = 76. The net loss is 150 − 92 − 76 = −18.

Reasons for protection. Protecting an infant industry until it gains scale; shielding a declining industry to ease job losses; national security and food security; responding to dumping (selling below cost abroad); raising revenue; diversifying a narrow economy; and, in a weak balance of payments position, limiting imports.

Consequences. Higher prices and less choice for consumers; less pressure on protected firms to be efficient; higher costs for firms that use imported inputs; a fall in exports if other countries retaliate; possible disputes with trade partners. Evaluate by asking whether the protection is temporary, whether the country is large enough to affect world prices, and how well the targeted industry can in fact become competitive.

6. The changing pattern of world trade

In broad terms: the share of trade in manufactured goods and services has grown, emerging economies account for a rising share of world exports, trade within industries and within supply chains has grown, and falling transport and communication costs and lower tariffs have supported all of these. Country comparative advantages have shifted as capital, skills and technology have spread. Link each trend to a cause from section 2.

7. Trading blocs and the WTO

Bloc	Members	Common external tariff	Free movement of labour and capital	Single currency
Free trade area	Remove barriers to trade between themselves	No: each sets its own	No	No
Customs union	As above	Yes	No	No
Common market	As above	Yes	Yes	No
Monetary union	As above	Yes	Yes	Yes

Each stage is deeper. Gains include a bigger home market, economies of scale and more competition. Costs include trade being steered towards members even where a non-member is cheaper, loss of independent policy-making, and in a monetary union the loss of the country’s own exchange rate and interest rate.

The World Trade Organisation (WTO) is the body that sets rules for trade between its members. Its roles include providing a forum for negotiating lower trade barriers, administering agreements, monitoring members’ trade policies and settling disputes between members. Its principle of non-discrimination means members should treat other members equally. Evaluate its power: it relies on members accepting its rulings, negotiations are slow, and developing countries may have less influence.

Common errors

• Claiming that a country which is better at making everything has nothing to gain from trade.
• Reading comparative advantage from total output instead of from opportunity cost.
• Inverting the terms of trade fraction.
• Treating a quota’s gain as government revenue.
• Writing “terms of trade improved so the current account improved” without elasticities.

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.