Skip to main content
EnglandEconomicsSyllabus dot point

Why do countries trade, and what does the theory of comparative advantage say about the gains from trade?

2.4 International trade: absolute and comparative advantage, the gains from specialisation and trade, the terms of trade, and the limitations of comparative advantage.

An OCR H460 answer to international trade, covering absolute and comparative advantage, how specialisation and trade raise total output, the terms of trade, and the assumptions and limitations of the theory of comparative advantage.

Generated by Claude Opus 4.811 min answer

Reviewed by: AI editorial process; not yet individually human-reviewed

Have a quick question? Jump to the Q&A page

Jump to a section
  1. What this dot point is asking
  2. Absolute and comparative advantage
  3. The gains from specialisation and trade
  4. The terms of trade
  5. The limitations of comparative advantage
  6. Examples in context
  7. Try this

What this dot point is asking

OCR wants you to distinguish absolute from comparative advantage, to explain how specialisation according to comparative advantage raises total output and benefits trading partners, to define the terms of trade, and to evaluate the limitations of the theory.

Absolute and comparative advantage

The key insight (David Ricardo) is that even a country with an absolute advantage in everything still gains by specialising where its comparative advantage is greatest and importing the rest, because specialisation frees resources for their most productive use.

The gains from specialisation and trade

The terms of trade

An improvement in the terms of trade is not always good: if it comes from a stronger currency that hurts export competitiveness, it can worsen the trade balance. The terms of trade matter especially for developing economies dependent on volatile commodity exports.

The limitations of comparative advantage

The theory makes strong assumptions that limit it in practice: it assumes no transport costs, perfect mobility of factors within a country, constant returns to scale, free trade with no barriers, and no externalities. In reality, transport costs and trade barriers reduce gains, factors are immobile (so structural unemployment can follow as industries decline), specialisation can leave a country over-dependent on a few volatile products, and production may carry environmental externalities. Gains from trade may also be unevenly distributed between and within countries.

Examples in context

  • Global supply chains. Countries specialise in stages of production (design, components, assembly) according to comparative advantage, as in electronics manufacturing.
  • Commodity dependence. Some developing economies specialise in a single commodity, gaining from trade but exposed to price swings and deteriorating terms of trade.
  • Services trade. The UK has a comparative advantage in financial and professional services, a large share of its exports.

Try this

Q1. Distinguish between absolute and comparative advantage. [4 marks]

  • Cue. Absolute: producing with fewer resources; comparative: producing at a lower opportunity cost.

Q2. Explain what an improvement in the terms of trade means. [3 marks]

  • Cue. Export prices rise relative to import prices, so a given quantity of exports buys more imports.

Exam-style practice questions

Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

OCR H460/02 20205 marksCountry A can produce 1 unit of cloth for every 4 units of wheat it gives up; Country B can produce 1 unit of cloth for every 2 units of wheat it gives up. Using comparative advantage, explain which country should specialise in cloth.
Show worked answer →

A short structured question on comparative advantage (lower opportunity cost).

The opportunity cost of 1 unit of cloth is 4 wheat in Country A but only 2 wheat in Country B. Because Country B gives up less wheat to produce cloth, Country B has the comparative advantage in cloth and should specialise in it. By implication, Country A has the comparative advantage in wheat (its opportunity cost of wheat is lower: 0.25 cloth versus 0.5 cloth in B).

So B specialises in cloth, A in wheat, and both can gain by trading at a rate between the two opportunity-cost ratios. Markers reward comparing opportunity costs, identifying B's comparative advantage in cloth, and the conclusion.

OCR H460/02 202212 marksAssess the view that free trade based on comparative advantage always benefits all countries involved.
Show worked answer →

A levels-of-response question. Knowledge and application: explain comparative advantage (specialise where opportunity cost is lowest) and the gains from trade (higher total output, lower prices, more choice, economies of scale).

Analysis: develop how specialisation and trade can raise world output and living standards.

Evaluation: challenge "always" and "all". The model's assumptions (no transport costs, perfect mobility of factors, constant returns, no externalities) rarely hold; gains may be unevenly distributed; specialisation can leave a country over-dependent on volatile commodity prices; and structural unemployment can follow as industries decline. Conclude with a supported judgement: trade tends to raise total welfare but not necessarily for every country or group, depending on terms of trade and adjustment costs.

Related dot points

Sources & how we know this