’3.1: Why do countries trade?



  1. World Trade Organization is an international body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nations.
  2. A country has a Comparative Advantage in the production of a good when it is able to produce a good at lower opportunity cost of resources than another country.
  3. A country had an Absolute Advantage in the production of a good when it is able to produce more output than other countries using the same input of factors of production.


Gains from international trade


1. Lower prices

  • Ability to buy goods and services at a lower price than the domestic one.
  • Consumers are able to buy less expensive products.
  • Producers are able to purchase cheaper raw materials and semi-manufactured goods.
  • Prices may be lower in some countries than others because of access to natural resources, differences in the quality of labor forces, quality of capital and levels of technology.

2. Greater choice

  • Enables consumers to have a greater choice of products.
  • Not only have access to domestic products, but also foreign products.

3. Differences in resources

  • Different countries have more quantities of a certain material than other countries.
  • Some resources country may need, but doesn’t have.
  • In order to get resources, countries must export products to earn foreign currencies and buy the resources necessary for them.

4. Economies of scale

  • International trade → Increase in market size and demand → Increase in level of production and size of production units → Increase in efficiency → More competition → Reduction in long-run average costs.
  • Larger production scale → Enables more specialization.
  • Larger production scale → Greater scope of division of labor

5. Increased competition

  • International trade → Increased competition → Greater efficiency → Consumers are offered cheaper goods and services and increase in variety of goods available to them.

6. More efficient allocation of resources

  • Without government intervention, countries that specialize in producing certain goods and services will produce them at lower prices and increase their efficiency.
  • If this happens at all countries, then the world’s resources are allocated efficiently when free trade takes place.

7. Source of foreign exchange

  • Enables consumers to obtain foreign currencies.
  • Beneficial for developing countries as some of them don’t have convertible currency.


World Trade Organization


  • International organization that sets the rules for global trading.
  • Resolves disputes between its member countries.
  • Aims of the World Trade Organization (WTO) are:
  1. Administer WTO trade agreements.
  2. Be a forum for trade negotiations.
  3. Handle trade disputes among member countries.
  4. Monitor national trade policies.
  5. Provide technical assistance and training for developing countries.
  6. Cooperate with other international organizations.


Absolute Advantage vs. Comparative Advantage


1. Absolute Advantage

  • A country has this in the production of a good if it can produce it using fewer resources than another country.
  • Shows which country specializes in what kind of product compared to another country for the same product.


2. Comparative Advantage

  • A country has this in the production of a good if it can produce the good at a lower opportunity cost than another country.
  • Country with the higher opportunity cost should specialize in the product compared to another country for the same product.






●       Factors that gives a country a comparative advantage:

  • A country that is provided with large amount of land → comparative advantage on agricultural products.
  • A country with abundant unskilled labor → comparative advantage on labor-intensive, low-skilled, manufactured goods.
  • A country with abundant well-educated labor → comparative advantage on financial services.
  • A country with favorable weather and climate → comparative advantage on tourist services.

●       Limitations/Assumptions of comparative advantage theory:

  • In perfect competition, it’s assumed that the producers and consumers have the perfect knowledge and are aware of where the least expensive goods may be purchased. In reality, it’s not true as consumers aren’t aware of where most of the products they consume are produced.
  • There’s no transportation costs involved. In reality, this is not true as the transport costs will reduce a country’s comparative advantage and not making international trading worthwhile, resulting in eliminating competition..
  • Only two economics produce two goods. However, this theory can be applied to multiple countries and multiple products and it is still possible to recognize which country has the comparative advantage for a product.
  • Costs don’t change and there’s no economies or diseconomies of scale. However, economies of scale would increase a country’s comparative advantage as the costs of production fall heavily as a result of it.
  • Goods being traded are identical. However, problems arise when the goods being traded are consumer durables aka products that have a long product life cycle. Therefore, it will be harder to prove which country has a more comparative advantage on these types of products as they last longer than others.
  • Factors of production remain in the country. This is not true as developed countries tend to invest capital on developing countries to produce goods there. Also, labor workforce might migrate from low-wage to high-wage countries.
  • There’s a perfect free trade among countries. However, this isn’t likely as there’s a high chance that government will intervene and create trade barriers in many industries.


Paper 3 Question


Using the same quantities of resources, to produce rice and cloth, China and Pakistan have the following production outcomes: