AQA A-Level Economics (7136)

## Learning Outcomes

- Understand why countries trade and how specialisation can raise output and welfare
- Explain the difference between **absolute advantage** and **comparative advantage**
- Calculate **opportunity cost**, the **terms of trade index**, and the **balance of trade in goods and services**
- Identify the main gains from trade and the main limits of free trade theory
- Explain how **tariffs**, **quotas** and **export subsidies** affect consumers, producers and welfare
- Assess the likely macroeconomic effects of trade on growth, inflation, employment, the balance of payments and the exchange rate

## AQA A-Level Economics (7136) Syllabus

For the AQA A-Level Economics (7136), you are expected to understand trade within the international economy, with a focus on the following syllabus points:

![International trade concepts including comparative advantage, terms of trade, protectionism, and macroeconomic effects.](https://static.pastpaperhero.com/images/aqa-a-level-economics-7136-the-international-economy-trade_00.png)

_Trade analysis links specialisation and opportunity cost to trade measures, protectionist instruments, and wider macroeconomic outcomes._

- Know the theories of international trade, including **absolute advantage** and **comparative advantage**
- Explain **specialisation** and the **gains from trade**
- Understand **opportunity cost** as the basis of comparative advantage
- Calculate and interpret the **terms of trade** using the index formula
- Measure trade using the **balance of trade in goods and services**
- Identify influences on trade patterns and trade flows, including cheaper labour and components, trade blocs, and the rise of **China** and **India**
- Explain and assess **protectionism**, including **tariffs**, **quotas** and **export subsidies**
- Analyse the significance of trade relationships for growth, inflation, employment, the balance of payments, the exchange rate, and policy choices

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. What is the difference between absolute advantage and comparative advantage?
2. How do you calculate the terms of trade index?
3. Why can two countries both gain from trade even if one is better at producing every good?
4. What is the difference between a tariff and a quota?
5. How can more international trade affect inflation and employment in the UK?

## Introduction

Trade means the exchange of goods and services between countries. It matters because it links microeconomic ideas, such as costs and competition, to macroeconomic outcomes such as growth, inflation, employment and the balance of payments.

For AQA, this topic often tests both theory and application. You need to know the basic models clearly, but you also need to evaluate them. Free trade can raise welfare, yet the gains are not always evenly shared and protectionism may sometimes be defended.

> **Key Term: international trade**
> The exchange of goods and services between countries through exports and imports.

### Why countries trade: specialisation and advantage

Countries trade because resources are unevenly spread, production costs differ, and consumers and firms want goods that cannot be produced as cheaply at home. Trade allows countries to specialise and then exchange output.

> **Key Term: specialisation**
> The concentration of production in goods or services in which a country is relatively more efficient.

A country may have an **absolute advantage** or a **comparative advantage**.

> **Key Term: absolute advantage**
> The ability to produce more output with the same resources, or the same output with fewer resources, than another producer.
> **Key Term: comparative advantage**
> The ability to produce a good or service at a lower opportunity cost than another producer.

The key idea is that trade is based on relative cost, not just who produces most. That is why comparative advantage matters more than absolute advantage.

> **Key Term: opportunity cost**
> The next best alternative foregone when a choice is made.

Worked example:

Suppose one unit of resources can produce:

- UK: 10 cars or 20 tonnes of wheat
- India: 6 cars or 18 tonnes of wheat

Step 1: Identify absolute advantage.

- In cars, UK produces 10 and India 6, so UK has absolute advantage.
- In wheat, UK produces 20 and India 18, so UK also has absolute advantage.

So the UK is better at producing both goods in absolute terms.

Step 2: Calculate opportunity costs.

For the UK:

- 1 car costs 2 tonnes of wheat, because 10 cars = 20 wheat
- 1 tonne of wheat costs 0.5 cars

For India:

- 1 car costs 3 tonnes of wheat, because 6 cars = 18 wheat
- 1 tonne of wheat costs 1/3 of a car

Step 3: Identify comparative advantage.

- UK has lower opportunity cost in cars: 2 tonnes of wheat instead of 3
- India has lower opportunity cost in wheat: 1/3 of a car instead of 0.5

So:

- UK should specialise relatively more in cars
- India should specialise relatively more in wheat

This can increase total world output and create potential gains from trade.

> **Test Tip:**
> In calculation questions, always show the opportunity cost for both countries and both goods. Students often stop after spotting who has the highest output, which only gives absolute advantage.

Main gains from trade:

- lower average costs from economies of scale
- more competition, which may reduce prices
- greater consumer choice
- access to cheaper raw materials, components and labour
- wider production possibilities and consumption possibilities
- possible improvements in efficiency and innovation

However, these are potential gains, not guaranteed gains. Some workers and regions may lose if import competition causes structural unemployment.

Common student errors:

- confusing comparative advantage with absolute advantage
- forgetting to calculate opportunity cost
- assuming all countries gain equally
- claiming specialisation is always complete in real life

### Measuring trade and understanding terms of trade

AQA expects a clear distinction between trade flows, trade balances and price ratios.

> **Key Term: balance of trade in goods and services**
> The value of exports of goods and services minus the value of imports of goods and services.

If exports exceed imports, there is a surplus. If imports exceed exports, there is a deficit.

Worked example:

- Exports of goods and services = £820 billion
- Imports of goods and services = £860 billion

Balance of trade in goods and services  
= exports − imports  
= £820bn − £860bn  
= **−£40bn**

So there is a **£40 billion trade deficit** in goods and services.

Do not confuse this with the **current account**, which is wider.

> **Key Term: terms of trade**
> The ratio of export prices to import prices, usually shown as an index.

Formula:

Terms of trade index = (export price index / import price index) × 100

Worked example:

- Export price index = 120
- Import price index = 150

Terms of trade index  
= (120 / 150) × 100  
= 0.8 × 100  
= **80**

If the index rises, the terms of trade improve. This means export prices have risen relative to import prices, so the country can buy more imports for a given quantity of exports.

An improvement in terms of trade may:

- raise real purchasing power
- make imports relatively cheaper compared with export earnings
- help living standards

But it may also:

- reduce export competitiveness if export prices have risen
- lower export volumes if demand is elastic
- worsen the balance of trade

So better terms of trade are not always better overall.

> **Test Tip:**
> If the question asks about terms of trade, do not switch into balance of trade analysis only. Terms of trade is a price ratio, not the difference between export and import values.

Trade patterns also change over time. Important influences include:

- the emergence of **China** and **India** as major trading nations
- access to cheaper raw materials, components and labour
- falling transport and communication costs
- trade blocs with reduced barriers to trade
- exchange rate movements
- changes in non-price competitiveness

For the UK, trade in services is especially important, while trade in goods is often in deficit. This matters for growth and employment because some sectors expand while others contract.

### Protectionism: tariffs, quotas and export subsidies

**Protectionism** means government policies designed to reduce imports or support domestic firms against foreign competition.

> **Key Term: protectionism**
> Government action to restrict imports or support domestic producers in international trade.

The main forms named by AQA are tariffs, quotas and export subsidies.

> **Key Term: tariff**
> A tax on imports.
> **Key Term: quota**
> A physical limit on the quantity of imports allowed into a country.
> **Key Term: export subsidy**
> Government financial support that lowers exporters’ costs or raises the return from selling abroad.

Tariffs and quotas both tend to:

- raise the domestic price
- reduce imports
- help domestic producers
- harm consumers through higher prices and less choice
- create a net welfare loss

Key difference:

- a **tariff** creates government revenue
- a **quota** creates **quota rent**, which may go to licence holders, importers, foreign firms or the government if licences are auctioned

Tariff analysis:

If a tariff raises the domestic price:

- domestic supply rises
- domestic demand falls
- imports shrink

Winners:

- domestic producers
- government, through tariff revenue

Losers:

- consumers
- the economy overall, due to deadweight welfare loss

Quota analysis:

If a quota fixes the number of imports:

- domestic price rises until the market clears
- imports are capped at the quota amount

Winners:

- domestic producers
- whoever receives quota rent

Losers:

- consumers
- overall welfare

A quota may be more certain than a tariff in restricting import volume, especially if import demand is inelastic.

Export subsidies work differently. They help domestic firms sell abroad by cutting effective costs or raising returns. This may raise output and employment in the short run, but it can be expensive for governments and may distort resource allocation.

Arguments for protectionism:

- **infant industry**: new domestic firms may need temporary protection until they reach economies of scale
- **strategic industry**: some industries matter for national security or long-run competitiveness
- **anti-dumping**: protection may stop foreign firms selling below cost to drive local firms out
- **employment**: protection may slow job losses in industries under import pressure
- **balance of payments**: lower imports may reduce a trade deficit

Arguments against protectionism:

- higher prices for consumers
- reduced competition and lower efficiency
- less incentive to innovate
- risk of retaliation from trading partners
- possible misallocation of resources
- protection may remain long after the original case has disappeared

Strategic trade theory adds a useful evaluation point. In industries with increasing returns to scale and imperfect competition, some economists argue that government intervention may improve outcomes. This weakens the simple claim that free trade is always best.

Common student errors:

- saying quotas always generate government revenue
- forgetting consumers are the main losers from protectionism
- treating all protection as permanent rather than temporary
- giving only one side of the argument

### How trade affects the wider economy and how to structure evaluative answers

Trade has both micro and macro effects, which makes it very useful in Paper 3.

Effects on macroeconomic performance:

- **economic growth**: rising exports increase aggregate demand and may also raise productive potential through competition and scale
- **inflation**: cheaper imports can reduce cost-push inflation, but tariffs or a weaker exchange rate can raise prices
- **employment**: export industries may create jobs, but import competition can cause structural unemployment
- **balance of payments**: stronger exports improve the trade balance in goods and services
- **exchange rate**: higher exports raise demand for the currency; higher imports raise supply of the currency
- **policy**: governments may use supply-side policy to improve competitiveness rather than rely only on protectionism

A strong evaluative answer should use the structure:

- on the one hand
- on the other hand
- it depends on

For example, if asked whether free trade benefits the UK:

On the one hand:

- consumers gain from lower prices and more choice
- firms can import cheaper components
- export markets may raise growth

On the other hand:

- some workers lose jobs in import-competing industries
- the UK may become too dependent on external demand
- benefits may be uneven across regions

It depends on:

- the price elasticity of demand for exports and imports
- non-price competitiveness
- whether adjustment support is available for displaced workers
- whether the industry is strategically important
- whether effects are short run or long run

How to structure an evaluative answer:

Start by defining the key concept precisely. Then use a chain of analysis linked to the context in the extract. If the case study mentions rising Chinese imports, discuss cheaper prices and lower inflation, but also import competition and structural unemployment. Use financial or numerical evidence if given, such as changes in export values, tariff rates or trade deficits. For evaluation, avoid generic lines. Instead, say what changes the conclusion: elasticities, time period, retaliation risk, labour mobility, and the strength of domestic supply-side response. End with a supported judgement.

> **Test Tip:**
> Paper 3 rewards application. Do not write a memorised trade essay. Use the country, industry, data and time period in the extract to decide which trade arguments matter most.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- International trade is the exchange of goods and services between countries
- Specialisation means focusing production on goods and services produced relatively efficiently
- Absolute advantage is about producing more with the same resources
- Comparative advantage is about lower opportunity cost
- Gains from trade come from specialisation, economies of scale, competition and greater choice
- The balance of trade in goods and services equals exports minus imports
- Terms of trade are measured by the formula (export price index / import price index) × 100
- Improved terms of trade do not always improve the balance of trade
- Protectionism includes tariffs, quotas and export subsidies
- Tariffs create government revenue, while quotas create quota rent
- Protectionism may protect jobs or infant industries, but usually raises prices and reduces efficiency
- Trade affects growth, inflation, employment, the balance of payments and the exchange rate

## Key Terms and Concepts

- international trade
- specialisation
- absolute advantage
- comparative advantage
- opportunity cost
- balance of trade in goods and services
- terms of trade
- protectionism
- tariff
- quota
- export subsidy


The International Economy - Trade