Why do countries trade, and when might protecting domestic industry be justified?
The basis for international trade, absolute and comparative advantage, the gains from trade, the methods and effects of protectionism, and the terms of trade.
A focused CCEA A-Level Economics answer on international trade, covering absolute and comparative advantage, the gains from specialisation and trade, the methods of protectionism (tariffs, quotas, subsidies and barriers), the arguments for and against protection, and the terms of trade, with a worked comparative-advantage example.
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What this dot point is asking
CCEA wants you to explain why countries trade, distinguish absolute from comparative advantage, show the gains from specialisation and trade, explain the methods of protectionism and the arguments for and against it, and define and interpret the terms of trade.
The basis for trade
The key insight, due to Ricardo, is that comparative, not absolute, advantage drives beneficial trade. Even if one country has an absolute advantage in everything, both countries gain if each specialises in the good in which it has the lower opportunity cost and they trade.
Methods of protectionism
Arguments for and against protection
The arguments for protection include the infant industry argument (shielding a new industry until it reaches economies of scale), protecting strategic industries (such as food or defence), preventing dumping (the sale of subsidised imports below cost), saving jobs in declining sectors, and correcting a trade deficit. The arguments against are that protection raises prices for consumers, protects inefficiency, sacrifices the gains from comparative advantage, risks retaliation and trade wars, and may simply delay necessary adjustment.
The terms of trade
A favourable movement in the terms of trade lets a country import more for the same exports, but if it comes from a stronger exchange rate it can also reduce export competitiveness, so the effect on the balance of payments depends on elasticities.
Try this
Q1. Define comparative advantage. [2 marks]
- Cue. The ability to produce a good at a lower opportunity cost than another country.
Q2. Explain the difference between a tariff and a quota. [3 marks]
- Cue. A tariff is a tax on imports that raises their price; a quota is a physical limit on the quantity of imports allowed.
Q3. Explain one argument for and one argument against protecting an infant industry. [4 marks]
- Cue. For: it can grow to achieve economies of scale and compete. Against: it may become permanently dependent, raise prices and protect inefficiency.
Exam-style practice questions
Practice questions written in the style of CCEA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
CCEA A2 26 marksExplain the theory of comparative advantage and how it leads to gains from trade.Show worked answer →
Worth 6 marks. Markers reward the definition based on opportunity cost, the principle of specialisation, and the mutual gain.
Comparative advantage: a country has a comparative advantage in a good if it can produce it at a lower opportunity cost than another country, that is by giving up less of other goods.
Specialisation: even if one country is better at producing everything (an absolute advantage in both), both can still gain if they specialise in the good in which they have the lower opportunity cost.
Gains from trade: by specialising and trading at a rate between the two domestic opportunity-cost ratios, total world output rises and both countries can consume beyond their own production possibility frontier.
Conclusion: comparative, not absolute, advantage is the basis for beneficial trade, which is why countries with very different productivity still trade to mutual benefit.
CCEA A2 28 marksEvaluate the case for a government using protectionist policies such as tariffs.Show worked answer →
Worth 8 marks. Evaluate requires the arguments for and against protection with a judgement.
Case for: protection can shield infant industries until they achieve economies of scale, defend strategic industries, prevent dumping of cheap subsidised imports, protect jobs in declining sectors, and correct a trade deficit.
Case against: tariffs and quotas raise prices for consumers, protect inefficient firms and reduce the gains from comparative advantage, can provoke retaliation and trade wars, and may simply delay necessary adjustment.
Welfare effect: a tariff diagram shows higher price, lower consumer surplus, some gain to domestic producers and government revenue, but a net welfare loss.
Judgement: protection can be justified temporarily for infant or strategic industries or against unfair dumping, but as a general policy it tends to reduce welfare and risk retaliation, so free trade with targeted, time-limited exceptions is usually preferable.
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Sources & how we know this
- CCEA GCE Economics specification — CCEA (2016)