9708 · 6.1

The reasons for international trade — practice questions

Practice and worked examples for 9708 The reasons for international trade. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

In 2020 (the base year), Malaysia's index of export prices and index of import prices were both 100. By 2023, the index of export prices had risen to 112, while the index of import prices had risen to 125.

(a) Calculate Malaysia's Terms of Trade for 2023. (b) Interpret the result. (c) Explain one possible consequence for Malaysia's current account.

Show solution outline

(a) Calculation of Terms of Trade (ToT) Formula: ToT = (Index of Export Prices / Index of Import Prices) x 100 ToT (2023) = (112 / 125) x 100 ToT (2023) = 0.896 x 100 = 89.6

(b) Interpretation The Terms of Trade for Malaysia in 2023 is 89.6. Since the base year value is 100, this represents a deterioration or an 'unfavourable' movement in the ToT. This means that, on average, Malaysia has to export more goods and services to be able to buy the same amount of imports as it could in 2020.

(c) Consequence for the Current Account A deterioration in the ToT, assuming the price elasticity of demand for both imports and exports is inelastic, could lead to a worsening of the current account balance. The total value of imports (P x Q) will rise by more than the total value of exports, increasing the trade deficit (or reducing the surplus).

Worked example 2

Country P and Country Q produce wheat and cloth. Output per worker per year:

	Wheat	Cloth
P	30	20
---	---	---
Q	20	40

(a) Which country has absolute advantage in each good? (b) Calculate opportunity cost ratios. (c) Identify comparative advantage and recommend specialisation.

Show solution outline

(a) Absolute advantage P in wheat (30 > 20). Q in cloth (40 > 20).

(b) Opportunity costs In P: 1 wheat costs 20/30 = 0.67 cloth; 1 cloth costs 30/20 = 1.5 wheat In Q: 1 wheat costs 40/20 = 2 cloth; 1 cloth costs 20/40 = 0.5 wheat

(c) Comparative advantage and specialisation P has lower OC in wheat (0.67 < 2) → comparative advantage in wheat Q has lower OC in cloth (0.5 < 1.5) → comparative advantage in cloth

P specialises in wheat; Q specialises in cloth — trade at terms of trade between 0.67 and 2 cloth per wheat benefits both.

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