International trade: absolute and comparative advantage, the gains from specialisation and trade, the terms of trade, the arguments for and against protectionism and its methods, and the role of trade blocs and the WTO.

What this key area is asking

International trade opens the global half of this area. You must explain absolute and comparative advantage, demonstrate the gains from specialisation and trade (ideally with a numerical example), interpret the terms of trade, weigh the arguments for and against protectionism and its methods, and describe the role of trade blocs and the World Trade Organisation. The core result, that trade based on comparative advantage raises world output, anchors the whole topic, and protectionism is the standard evaluation question.

Absolute and comparative advantage

The key insight, due to Ricardo, is that comparative, not absolute, advantage drives mutually beneficial trade. Even a country that is absolutely better at everything still has a comparative advantage in some goods (and a comparative disadvantage in others), because its opportunity costs differ from its trading partner's.

The gains from trade

By specialising according to comparative advantage and trading, countries can consume beyond their own production possibility frontiers:

• Each country concentrates resources on the goods it produces at lowest opportunity cost.
• Total world output rises because resources are used more efficiently.
• Trading at a rate between the two countries' opportunity-cost ratios lets both gain.

Other gains include greater variety and choice, economies of scale from larger markets, lower prices and a competitive spur to efficiency and innovation.

The terms of trade

Protectionism: methods and arguments

Methods of protection:

• Tariffs: taxes on imports, raising their price.
• Quotas: physical limits on the quantity imported.
• Subsidies to domestic producers, lowering their costs against imports.
• Non-tariff barriers: regulations, standards and administrative rules.

Arguments for protection: protecting infant industries until they reach efficient scale; protecting employment in declining industries; preventing dumping (selling below cost); correcting a current-account deficit; and strategic or national-security reasons.

Arguments against: protection raises prices for consumers and import-using firms, causes a welfare loss (deadweight loss), invites retaliation and trade wars, and protects inefficiency by removing the competitive spur, breaking the gains from comparative advantage.

The usual verdict: free trade generally raises welfare, so protection should be the exception, justified mainly for genuine infant industries, anti-dumping or strategic reasons, and ideally temporary and rules-based.

Trade blocs and the WTO

• Trade blocs (such as the EU single market) remove trade barriers between members, creating trade creation (cheaper goods from efficient partners) but also possible trade diversion (switching from a cheaper non-member to a dearer member). They deepen integration but can disadvantage outsiders.
• The World Trade Organisation (WTO) governs the rules of international trade, promotes multilateral liberalisation, and provides a mechanism to settle trade disputes. It aims to keep trade open and rules-based, though progress on global trade rounds has been slow.

For Scotland and the UK, leaving the EU single market is a current, examinable example of changing trade arrangements, and a natural project topic.

Worked example: comparative advantage with numbers

Why this matters

Comparative advantage is one of the most important and counter-intuitive results in economics, and the case for and against protectionism is a perennial exam and project topic, made vivid by trade wars, tariffs and Brexit. This topic also feeds directly into exchange rates and the balance of payments (the next topic) and into globalisation and development, so a secure grasp of the gains from trade underpins the whole global half of the area.

Try this

Q1. Define comparative advantage and state the rule it gives for what a country should produce. [2 marks]

• Cue. A comparative advantage is the ability to produce a good at a lower opportunity cost than others; a country should specialise in goods where its opportunity cost is lowest and trade for the rest.

Q2. Give one argument for and one argument against imposing a tariff on imports. [2 marks]

• Cue. For: protect an infant industry (or jobs, or against dumping). Against: it raises prices for consumers and causes a welfare loss, and may provoke retaliation.