9708 · 6.1
The reasons for international trade flashcards
Revision flashcards for Cambridge 9708 The reasons for international trade (syllabus 6.1). Flip, recall, then mark a real past-paper question.
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Absolute vs comparative advantage?
Absolute: produce more with same resources. Comparative: lower opportunity cost — basis for trade even if one country is absolutely better at everything.
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Opportunity cost ratio?
What must be given up of Good A to produce one more unit of Good B — country with lower OC has comparative advantage in B.
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Gains from trade?
Specialisation and exchange allow consumption combinations outside the pre-trade PPF — both countries can consume more than autarky.
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Terms of trade?
Index of export prices ÷ index of import prices × 100. Improvement means export prices rise relative to import prices.
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When does trade benefit both countries?
When the terms of trade lie between the two countries' opportunity cost ratios — each gains by exporting its comparative advantage good.
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Limitations to free trade theory?
Transport costs, immobile factors, protectionism, and unequal gains (some groups lose from specialisation).
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What is comparative advantage?
The ability of a country to produce a good or service at a lower opportunity cost than its trading partners. This is the fundamental principle underpinning modern trade theory.
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State the formula for the Terms of Trade (ToT).
Terms of Trade = (Index of average export prices / Index of average import prices) x 100. The base year is always 100.
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How does trade allow a country to consume beyond its PPC?
By specialising in producing the good where it has a comparative advantage and trading its surplus, a country can import other goods more cheaply than it could produce them domestically. This allows for a combination of goods for consumption that lies outside its own production possibilities.
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What is the key difference between absolute and comparative advantage?
Absolute advantage is based on using fewer inputs (higher productivity), while comparative advantage is based on having a lower opportunity cost. Trade can be beneficial based on comparative advantage even if one country has an absolute advantage in all goods.
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What condition must be met for the Terms of Trade to be mutually beneficial?
The agreed Terms of Trade (the rate of exchange between goods) must lie between the pre-trade opportunity cost ratios of the two trading countries.