Study Notes
International trade is driven by the concepts of absolute advantage and comparative advantage, which explain how countries can benefit from specializing in certain products and trading with others.
- Absolute advantage — A country can produce more of a product using the same resources compared to another country. Example: Indonesia has an absolute advantage in rice production.
- Comparative advantage — The ability to produce a good at a lower opportunity cost than others. Example: The USA specializes in coats due to a lower opportunity cost compared to Bangladesh.
- Free trade — Exchange of goods and services across borders without restrictions. Example: No taxes or limits on international trade.
- Terms of trade — The ratio between export prices and import prices. Example: A favorable movement means fewer exports are needed to purchase imports.
Exam Tips
Key Definitions to Remember
- Absolute advantage
- Comparative advantage
- Free trade
- Terms of trade
Common Confusions
- Mixing up absolute and comparative advantage
- Assuming all favorable terms of trade movements are beneficial
Typical Exam Questions
- What is absolute advantage? A country can produce more of a product using the same resources compared to another.
- How does comparative advantage benefit international trade? It allows countries to specialize in goods with lower opportunity costs, increasing efficiency.
- What factors can change the terms of trade? Demand and supply factors, inflation rates, exchange rates, and government policies.
What Examiners Usually Test
- Understanding of absolute and comparative advantage
- Benefits and limitations of specialization and free trade
- Causes and impacts of changes in the terms of trade