3.1. International economics - International trade
The benefits of trade
→ Explain that gains from trade include lower prices for consumers, greater choice for consumers, the ability of producers to
benefit from economies of scale, the ability to acquire needed resource, a more efficient allocation of resources, increased
competition, and a source of foreign exchange.
• Prices for consumers – generally lower price for products available for consumers
• Acquisition of needed resource – resources scarce in an economy (e.g. natural resources in Singapore) can be obtained
• Choice for consumers – allows consumers to choose from a variety of products
• Foreign exchange – trade is a source of foreign exchange; can obtain another economy’s currency
• Economies of scale – firms can gain access to larger market and expand output, gaining cost savings with economies of scale
• Efficient allocation of resources – resources will be allocated more efficiently with comparative advantage
• Competition – increases competition of goods, forcing domestic producers to increase their efficiency to compete
Restrictions on free trade: trade protection
→ Explain, using a tariff diagram, the effects of imposing a tariff on imported goods on different stakeholders including domestic
producers, foreign producers, consumers and the government
• Diagram explanation
▪ Before tariff: world price at Pworld, with imports at Q2-Q1 and domestic production at Q1.
▪ After tariff: world price increases to Pworld+tariff, with imports decreased at Q4-Q3 and domestic production increasing
to Q3. equilibrium quantity decreases as price increases according to law of demand
• Impact on stakeholders
▪ Domestic producers: revenue increases from (g) to (a+b +c+g+h)
▪ Foreign producers: revenue decreases from (h+i+j+k) to (i+j)
▪ Consumer: price increases from Pworld to Pworld + tariff, expenditure
changes from (g+h+i+j+k) to (a+b+c+d+e+g+h+i+j)
▪ Government: government revenue increases to (d + e)
▪ Market: market loses efficiency due to resource misallocation
▪ (f) indicates loss of consumer surplus
▪ (c) indicates loss of world efficiency
→ Explain, using a diagram, the effects of setting a quota on foreign producers on different stakeholders, including domestic
producers, foreign producers, consumers and the government.
• Diagram explanation
▪ Before quota: world price at Pworld, with imports at Q2-Q1 and domestic production at Q1.
▪ After quota: quota limits quantity of imports to Q3-Q2; results in new domestic supply curve at Sdomestic+quota, resulting
in higher price (Pquota) and lesser quantity (Q4), but with increased domestic production to Q1+Q4-Q3
• Impact on stakeholders
▪ Domestic producers: revenue increases from (a) to (a+f+i+j+c+d)
▪ Foreign producers: revenue decreases from (b+c+d+e) to (b+g+h)
▪ Consumer: price increases from Pworld to Pquota, expenditure
changes from (a+b+c+d+e) to (a+b+c+d+f+g+h+i+j), expenditure
changes from (g+h+i+j+k) to (a+b+c+d+e+g+h+i+j)
▪ Market: market loses efficiency due to resource misallocation
▪ (k) indicates loss of consumer surplus
▪ (j) indicates loss of world efficiency
→ Explain, using a diagram, the effect of giving a subsidy to domestic producers on different stakeholders, including domestic
producers, foreign producers, consumers and the government
• Diagram explanation
▪ Before subsidy: world price at Pworld, with imports at Q2-Q1 and domestic production at Q1.
▪ After quota: subsidy increases Sdomestic to Sdomestic+subsidy, so domestic production increases to Q3 while imports decrease
to Q2-Q3; price and quantity traded in a market remains the same
• Impact on stakeholders
▪ Domestic producers: revenue increases from (a) to (a+b+e+f+g)
▪ Foreign producers: revenue decreases from (b+c+d) to (c+d)
▪ Consumer: price remains the same, more domestic products are bought
▪ Government: opportunity costs for giving subsidy at (e+f+g)
▪ Market: market loses efficiency due to resource misallocation
▪ (g) indicates loss of world efficiency
,→ HL content: Calculate from diagrams the effects of imposing a tariff on imported goods on different stakeholders, including
domestic producers, foreign producers, consumers and the government.
→ HL content: Calculate from diagrams the effects of setting a quota on foreign producers on different stakeholders, including
domestic producers, foreign producers, consumers and the government.
→ HL content: Calculate from diagrams the effects of giving a subsidy to domestic producers on different stakeholders, including
domestic producers, foreign producers, consumers and the government.
→ Describe administrative barriers that may be used as a means of protection
• Administrative barriers: regulations and delay in import process that makes it more “difficult” to import
▪ Means of protectionism: more costly and inefficient for trade to occur, hindering willing to supply
→ Evaluate the effect of different types of trade protection
• Tariffs – tax charged on imported goods and services
▪ Advantage
▪ Protection of domestic market: introduction of trade affects domestic market less (anti-dumping measures)
▪ Less unemployment: domestic firms employ more workers to maintain the domestic quantity supplied
▪ Increased government revenue: source of income; tax revenue is gained from tariff
▪ Maintenance of health and safety standards: allows more ease in maintenance of standards
▪ Disadvantage
▪ Retaliation: tariff on imports risks domestic exports also being protected against
▪ Loss of world efficiency: not working under comparative advantage; less efficient resource allocation
▪ Less competition: less competition for domestic firms and less motive to be more productive
▪ Increased price for consumers: if goods are raw materials, tariff will increase cost of production
▪ Welfare loss: there is a loss in consumer surplus, causing welfare loss
• Subsidies – amount of money paid by the government to a firm, per unit of output
▪ Advantage
▪ Protection of domestic market: subsidy protects essential, sunset and infant industries against low prices
▪ Greater incentives to firms: promote growth of certain sectors of an economy
▪ Disadvantage
▪ Increase in government expenditure: there is a high opportunity cost with providing subsidies
▪ Loss of world efficiency: not working under comparative advantage; less efficient resource allocation
▪ Less competition: less competition for domestic firms and less motive to be more productive
▪ Susceptible to corruption: legislation process and input of money risks corruption
• Quota – restriction on the quantity limit on imports of a product set by a country
▪ Advantage
▪ Protection of domestic market: protects vulnerable industries against low prices (e.g. dumping)
▪ Less unemployment: sector requires more domestic employment; hence there is reduced unemployment
▪ Maintenance of health and safety standards: allows more ease in maintenance of standards
▪ Disadvantage
▪ Loss of world efficiency: not working under comparative advantage; less efficient resource allocation
▪ Less competition: less competition for domestic firms and less motive to be more productive
▪ Increased price for consumers: if goods are raw materials, quot will increase cost of production
▪ Welfare loss: there is a loss in consumer surplus, causing welfare loss
▪ Retaliation: tariff on imports risks domestic exports also being protected against
Arguments for and against trade protection (arguments against and for free trade)
→ Discuss the arguments in favour of trade protection, including the protection of domestic jobs, national security, protection of
infant industries, the maintenance of health, safety and environmental standards, anti-dumping and unfair competition, a means of
overcoming a balance of payments deficit and a source of government revenue
• Source of government revenue: source of government income that can be spent on other sectors of the economy
• National security and sovereignty: prevents over-reliance on another nation for essential goods (e.g. food)
• Anti-dumping and unfair competition: prevents harming of industry from dumping, and protects against unfair competition
• Protection of domestic jobs: high domestic production jobs are provided to domestic producers, not foreign producers
• Maintenance of standards: health, safety and environmental standards that may not be identical across the globe is implemented
• Overcoming balance of payment deficit: protectionism reduces import, hence can temporarily ensure balance of payment deficit
• Protection of vulnerable industries: protection of sunrise industries that are currently incapable to compete with large established
foreign firms; protection of sunset industries with large employment sector to prevent sudden increase in unemployment
→ Discuss the arguments against trade protection, including a misallocation of resources, the danger of retaliation and “trade
wars”, the potential for corruption, increased costs of production due to lack of competition, higher prices for domestic consumers,
increased costs of imported factors of production and reduced export competitiveness
• Misallocation of resources: comparative advantage is not fully explored, not resulting in maximized efficiency of production
• Dangers of retaliation and “trade wars”: countries imposing protectionism will face protectionism themselves
, • Potential for corruption: legislation process and excess bureaucracy risks corruption
• Less incentive to increase productivity: less competition is present and firms have less motivation to improve productivity
• Increased cost of production: higher prices in imports lead to an increase in cost of imported factor of production
• Higher prices for domestic consumers: domestic consumers may face higher prices and reduced consumer expenditure
• Reduced export competitiveness: decreased productivity and protectionism retaliation both reduce export competitiveness
Absolute and comparative advantage
→ HL content: Explain the theory of absolute advantage.
• Absolute advantage: when a country can produce goods at a lower
cost (i.e. unit of output per unit of input is higher)
→ HL content: Explain, using a diagram, the gains from trade arising from
a country’s absolute advantage in the production of a good.
• Specialization: when countries produce goods that they have absolute
advantage in, the total output (production outcome) will be much
higher than what they will have without trade
→ HL content: Explain the theory of comparative advantage.
• Comparative advantage: when a country can produce a good at a lower opportunity cost (not lower cost) than another
→ HL content: Draw a diagram to show comparative advantage.
• One country has absolute advantage in the production of both goods
→ HL content: Draw a diagram to illustrate comparative advantage from a
set of data.
• Slope of the line: shows the opportunity cost faced by countries
▪ Comparative advantage: the product where the gap
between potential production is the most different
▪ Diagram: country B has comparative advantage over
olives; country B has comparative advantage over oranges
→ HL content: Describe the sources of comparative advantage, including the differences between countries in factor endowments
and the levels of technology.
• Difference in factor endowments: countries endowed with specific factor will often have comparative advantage in such
▪ Abundance of a particular factor will make the price of this factor relatively lower than the price of other factors,
thereby allowing the opportunity cost of the goods of services to be lower than it would be for other countries
▪ Large amount of arable land: comparative advantage in agriculture
▪ Favorable climate and geographical location: comparative advantage in tourist services
▪ Large population of unskilled labour: comparative advantage in labor-intensive, low skilled manufactured goods
▪ Large population of educated labour: comparative advantage in the output of financial services
• Levels of technology: countries with high level of technology may often have absolute advantage over both products, but are
likely to face differing degree of comparative advantage
→ HL content: Calculate opportunity costs from a set of data in order to identify comparative advantage.
• Calculating opportunity costs
▪ Opportunity cost of A: identify opportunity
cost of per unit A by B (o. cost = qA/qB)
▪ Opportunity cost of B: identify opportunity
cost of per unit B by A (o. cost = qB/qA)
▪ Comparison: compare opportunity costs
and identify comparative advantage
→ HL content: Discuss the real-world relevance and limitations of the theory of comparative advantage, considering factors
including the assumptions on which it rests, and the costs and benefits of specialization (a full discussion must take into account
arguments in favour and against free trade and protection).
• Assumptions on which comparative advantage rests
▪ Perfect knowledge: assumes producers and consumers have perfect knowledge and are aware of where the least
expensive goods may be purchased in an economy
▪ Transport cost: assume there are no transport cost involved that could erode a nation’s comparative advantage
▪ Returns to scale: assumes there are no diseconomies or economies of scale, which enhances comparative advantage
▪ Identical products: assumed that products are all identical; which may not be the case (e.g. computer brands)
▪ No trade barriers: assumes there are no protectionist barriers that hinders free trade between nations
The benefits of trade
→ Explain that gains from trade include lower prices for consumers, greater choice for consumers, the ability of producers to
benefit from economies of scale, the ability to acquire needed resource, a more efficient allocation of resources, increased
competition, and a source of foreign exchange.
• Prices for consumers – generally lower price for products available for consumers
• Acquisition of needed resource – resources scarce in an economy (e.g. natural resources in Singapore) can be obtained
• Choice for consumers – allows consumers to choose from a variety of products
• Foreign exchange – trade is a source of foreign exchange; can obtain another economy’s currency
• Economies of scale – firms can gain access to larger market and expand output, gaining cost savings with economies of scale
• Efficient allocation of resources – resources will be allocated more efficiently with comparative advantage
• Competition – increases competition of goods, forcing domestic producers to increase their efficiency to compete
Restrictions on free trade: trade protection
→ Explain, using a tariff diagram, the effects of imposing a tariff on imported goods on different stakeholders including domestic
producers, foreign producers, consumers and the government
• Diagram explanation
▪ Before tariff: world price at Pworld, with imports at Q2-Q1 and domestic production at Q1.
▪ After tariff: world price increases to Pworld+tariff, with imports decreased at Q4-Q3 and domestic production increasing
to Q3. equilibrium quantity decreases as price increases according to law of demand
• Impact on stakeholders
▪ Domestic producers: revenue increases from (g) to (a+b +c+g+h)
▪ Foreign producers: revenue decreases from (h+i+j+k) to (i+j)
▪ Consumer: price increases from Pworld to Pworld + tariff, expenditure
changes from (g+h+i+j+k) to (a+b+c+d+e+g+h+i+j)
▪ Government: government revenue increases to (d + e)
▪ Market: market loses efficiency due to resource misallocation
▪ (f) indicates loss of consumer surplus
▪ (c) indicates loss of world efficiency
→ Explain, using a diagram, the effects of setting a quota on foreign producers on different stakeholders, including domestic
producers, foreign producers, consumers and the government.
• Diagram explanation
▪ Before quota: world price at Pworld, with imports at Q2-Q1 and domestic production at Q1.
▪ After quota: quota limits quantity of imports to Q3-Q2; results in new domestic supply curve at Sdomestic+quota, resulting
in higher price (Pquota) and lesser quantity (Q4), but with increased domestic production to Q1+Q4-Q3
• Impact on stakeholders
▪ Domestic producers: revenue increases from (a) to (a+f+i+j+c+d)
▪ Foreign producers: revenue decreases from (b+c+d+e) to (b+g+h)
▪ Consumer: price increases from Pworld to Pquota, expenditure
changes from (a+b+c+d+e) to (a+b+c+d+f+g+h+i+j), expenditure
changes from (g+h+i+j+k) to (a+b+c+d+e+g+h+i+j)
▪ Market: market loses efficiency due to resource misallocation
▪ (k) indicates loss of consumer surplus
▪ (j) indicates loss of world efficiency
→ Explain, using a diagram, the effect of giving a subsidy to domestic producers on different stakeholders, including domestic
producers, foreign producers, consumers and the government
• Diagram explanation
▪ Before subsidy: world price at Pworld, with imports at Q2-Q1 and domestic production at Q1.
▪ After quota: subsidy increases Sdomestic to Sdomestic+subsidy, so domestic production increases to Q3 while imports decrease
to Q2-Q3; price and quantity traded in a market remains the same
• Impact on stakeholders
▪ Domestic producers: revenue increases from (a) to (a+b+e+f+g)
▪ Foreign producers: revenue decreases from (b+c+d) to (c+d)
▪ Consumer: price remains the same, more domestic products are bought
▪ Government: opportunity costs for giving subsidy at (e+f+g)
▪ Market: market loses efficiency due to resource misallocation
▪ (g) indicates loss of world efficiency
,→ HL content: Calculate from diagrams the effects of imposing a tariff on imported goods on different stakeholders, including
domestic producers, foreign producers, consumers and the government.
→ HL content: Calculate from diagrams the effects of setting a quota on foreign producers on different stakeholders, including
domestic producers, foreign producers, consumers and the government.
→ HL content: Calculate from diagrams the effects of giving a subsidy to domestic producers on different stakeholders, including
domestic producers, foreign producers, consumers and the government.
→ Describe administrative barriers that may be used as a means of protection
• Administrative barriers: regulations and delay in import process that makes it more “difficult” to import
▪ Means of protectionism: more costly and inefficient for trade to occur, hindering willing to supply
→ Evaluate the effect of different types of trade protection
• Tariffs – tax charged on imported goods and services
▪ Advantage
▪ Protection of domestic market: introduction of trade affects domestic market less (anti-dumping measures)
▪ Less unemployment: domestic firms employ more workers to maintain the domestic quantity supplied
▪ Increased government revenue: source of income; tax revenue is gained from tariff
▪ Maintenance of health and safety standards: allows more ease in maintenance of standards
▪ Disadvantage
▪ Retaliation: tariff on imports risks domestic exports also being protected against
▪ Loss of world efficiency: not working under comparative advantage; less efficient resource allocation
▪ Less competition: less competition for domestic firms and less motive to be more productive
▪ Increased price for consumers: if goods are raw materials, tariff will increase cost of production
▪ Welfare loss: there is a loss in consumer surplus, causing welfare loss
• Subsidies – amount of money paid by the government to a firm, per unit of output
▪ Advantage
▪ Protection of domestic market: subsidy protects essential, sunset and infant industries against low prices
▪ Greater incentives to firms: promote growth of certain sectors of an economy
▪ Disadvantage
▪ Increase in government expenditure: there is a high opportunity cost with providing subsidies
▪ Loss of world efficiency: not working under comparative advantage; less efficient resource allocation
▪ Less competition: less competition for domestic firms and less motive to be more productive
▪ Susceptible to corruption: legislation process and input of money risks corruption
• Quota – restriction on the quantity limit on imports of a product set by a country
▪ Advantage
▪ Protection of domestic market: protects vulnerable industries against low prices (e.g. dumping)
▪ Less unemployment: sector requires more domestic employment; hence there is reduced unemployment
▪ Maintenance of health and safety standards: allows more ease in maintenance of standards
▪ Disadvantage
▪ Loss of world efficiency: not working under comparative advantage; less efficient resource allocation
▪ Less competition: less competition for domestic firms and less motive to be more productive
▪ Increased price for consumers: if goods are raw materials, quot will increase cost of production
▪ Welfare loss: there is a loss in consumer surplus, causing welfare loss
▪ Retaliation: tariff on imports risks domestic exports also being protected against
Arguments for and against trade protection (arguments against and for free trade)
→ Discuss the arguments in favour of trade protection, including the protection of domestic jobs, national security, protection of
infant industries, the maintenance of health, safety and environmental standards, anti-dumping and unfair competition, a means of
overcoming a balance of payments deficit and a source of government revenue
• Source of government revenue: source of government income that can be spent on other sectors of the economy
• National security and sovereignty: prevents over-reliance on another nation for essential goods (e.g. food)
• Anti-dumping and unfair competition: prevents harming of industry from dumping, and protects against unfair competition
• Protection of domestic jobs: high domestic production jobs are provided to domestic producers, not foreign producers
• Maintenance of standards: health, safety and environmental standards that may not be identical across the globe is implemented
• Overcoming balance of payment deficit: protectionism reduces import, hence can temporarily ensure balance of payment deficit
• Protection of vulnerable industries: protection of sunrise industries that are currently incapable to compete with large established
foreign firms; protection of sunset industries with large employment sector to prevent sudden increase in unemployment
→ Discuss the arguments against trade protection, including a misallocation of resources, the danger of retaliation and “trade
wars”, the potential for corruption, increased costs of production due to lack of competition, higher prices for domestic consumers,
increased costs of imported factors of production and reduced export competitiveness
• Misallocation of resources: comparative advantage is not fully explored, not resulting in maximized efficiency of production
• Dangers of retaliation and “trade wars”: countries imposing protectionism will face protectionism themselves
, • Potential for corruption: legislation process and excess bureaucracy risks corruption
• Less incentive to increase productivity: less competition is present and firms have less motivation to improve productivity
• Increased cost of production: higher prices in imports lead to an increase in cost of imported factor of production
• Higher prices for domestic consumers: domestic consumers may face higher prices and reduced consumer expenditure
• Reduced export competitiveness: decreased productivity and protectionism retaliation both reduce export competitiveness
Absolute and comparative advantage
→ HL content: Explain the theory of absolute advantage.
• Absolute advantage: when a country can produce goods at a lower
cost (i.e. unit of output per unit of input is higher)
→ HL content: Explain, using a diagram, the gains from trade arising from
a country’s absolute advantage in the production of a good.
• Specialization: when countries produce goods that they have absolute
advantage in, the total output (production outcome) will be much
higher than what they will have without trade
→ HL content: Explain the theory of comparative advantage.
• Comparative advantage: when a country can produce a good at a lower opportunity cost (not lower cost) than another
→ HL content: Draw a diagram to show comparative advantage.
• One country has absolute advantage in the production of both goods
→ HL content: Draw a diagram to illustrate comparative advantage from a
set of data.
• Slope of the line: shows the opportunity cost faced by countries
▪ Comparative advantage: the product where the gap
between potential production is the most different
▪ Diagram: country B has comparative advantage over
olives; country B has comparative advantage over oranges
→ HL content: Describe the sources of comparative advantage, including the differences between countries in factor endowments
and the levels of technology.
• Difference in factor endowments: countries endowed with specific factor will often have comparative advantage in such
▪ Abundance of a particular factor will make the price of this factor relatively lower than the price of other factors,
thereby allowing the opportunity cost of the goods of services to be lower than it would be for other countries
▪ Large amount of arable land: comparative advantage in agriculture
▪ Favorable climate and geographical location: comparative advantage in tourist services
▪ Large population of unskilled labour: comparative advantage in labor-intensive, low skilled manufactured goods
▪ Large population of educated labour: comparative advantage in the output of financial services
• Levels of technology: countries with high level of technology may often have absolute advantage over both products, but are
likely to face differing degree of comparative advantage
→ HL content: Calculate opportunity costs from a set of data in order to identify comparative advantage.
• Calculating opportunity costs
▪ Opportunity cost of A: identify opportunity
cost of per unit A by B (o. cost = qA/qB)
▪ Opportunity cost of B: identify opportunity
cost of per unit B by A (o. cost = qB/qA)
▪ Comparison: compare opportunity costs
and identify comparative advantage
→ HL content: Discuss the real-world relevance and limitations of the theory of comparative advantage, considering factors
including the assumptions on which it rests, and the costs and benefits of specialization (a full discussion must take into account
arguments in favour and against free trade and protection).
• Assumptions on which comparative advantage rests
▪ Perfect knowledge: assumes producers and consumers have perfect knowledge and are aware of where the least
expensive goods may be purchased in an economy
▪ Transport cost: assume there are no transport cost involved that could erode a nation’s comparative advantage
▪ Returns to scale: assumes there are no diseconomies or economies of scale, which enhances comparative advantage
▪ Identical products: assumed that products are all identical; which may not be the case (e.g. computer brands)
▪ No trade barriers: assumes there are no protectionist barriers that hinders free trade between nations
