Edexcel Economics A 2015 Notes
Specialisation and Trade
● Comparative advantage: Lower opportunity cost of producing a good or service
● Theory of comparative advantage: Global output will increase if countries specialise in
goods in which they have a comparative advantage.
Assumptions and limitations of the theory of comparative advantage
Assumption: The average cost of production remains constant
Limitation: Increased specialisation might result in higher average costs due to diseconomies
of scale
Assumption: There are no trade barriers
Limitation: There are trade barriers such as tariffs. Trade barriers might distort comparative
advantage
Assumption: There are no transport costs
Limitation: Real life transport costs might distort comparative advantage
Advantages and disadvantages of specialisation and trade in the real world
Advantage: Increase in global output and therefore an increase in living standards
Disadvantage: Benefits of specialisation and trade are based on unrealistic assumptions
(above).
Advantage: Access to larger markets can lead to economies of scale
Disadvantage: Might lead to an over dependence on imports and exports
Advantage: Leads to lower prices and more choice for consumers
Disadvantage: Increased specialisation can lead to decreased motivation, decreasing
productivity, and increasing prices as a result. (Demotivation due to ABC: Alienation,
Bureaucracy, Poor Communication)
Globalisation
Globalisation: The increased integration of different economies around the world
, 5 Characteristics of Globalisation
1. Increased international movement of labour
2. Increased international movement of financial capital
3. Increased specialisation
4. Increase in international trade
5. Increase in trade to GDP ratios
Trade to gdp ratios: (Total value of trade / GDP) * 100
4 Causes of Globalisation
1. Improvements in transportation (more available + cheaper)
2. Improvements in IT (the Internet, making the international movement of financial capital
easier)
3. Improvements in shipping such as containerisation (increasing the volume of
international trade, cheaper, more convenient)
4. Trade liberalisation (removal of trade barriers, eg. removal/decrease in tariffs)
Impacts of Globalisation
On Countries:
Advantage: Increased living standards caused by higher global output
Disadvantage: Might lead to an over dependence on imports and exports
On Governments:
Advantage: Increased tax revenue from increased output (corporation tax)
Disadvantage: Increase in transfer pricing (tax avoidance)
On Producers:
Advantage: Lower costs due to relocation to countries with lower wages
Disadvantage: Higher barriers of entry set up by TNCs (transnational corporations). TNCs can
achieve economies of scale with access to larger markets (eg. purchasing economies of scale,
bulk buy)
On Consumers:
Advantage: Lower prices and more choice
,Disadvantage: Consumers being driven to consume more can reduce consumer happiness
(Diderot effect)
On Workers:
Advantage: Increased international job opportunities (because of improvements in
transportation)
Disadvantage: Structural unemployment (Certain industries have been moved from developed
countries to developing countries due to lower costs, wages. Workers working in these
industries in developed countries have lost their jobs, no demand for their labour, their skills
don’t match the skills in demand)
Remittances: Money sent by a foreign worker to an individual in their home country (have
increased as a result of globalisation)
On the Environment:
Advantage: Increased cooperation between countries to tackle climate change
Disadvantage: Increased production → Negative externalities of production → Increased
pollution → Increase in global warming
Terms of Trade
Terms of trade: Relationship between the price of exports and the price of imports
Terms of trade ratio: (Index of export prices / index of import prices) * 100
Export prices increase relative to import prices → terms of trade have improved
Export prices decrease relative to import prices → terms of trade have deteriorated
4 Factors Impacting the Terms of Trade
1. Raw material prices (for exporting countries: increase in raw material prices → increase
in index of exports → improvement in terms of trade, opposite is true for importing
countries, and vice versa)
2. Tariffs (tax paid on imports) (adding/increasing tariffs → increase index of imports →
deteriorate terms of trade
, decreasing/removing tariffs → decrease in index of imports → improvement in terms of
trade)
3. Exchange rates (if a country’s currency appreciates → increase in index of exports and
decrease in index of imports → their terms of trade will improve, and vice versa)
4. Inflation rates (inflation: sustained increase in the general price level)
If a country’s inflation rate is lower than that of its trading partners then its index of import
prices will be rising more than its index of export prices. Therefore its terms of trade will
deteriorate. (the opposite is true)
Impact of Changes in a Country’s Terms of Trade
1. Living Standards (improvement of terms of trade will improve living standards,
deterioration of terms of trade will shrink living standards)
2. Competitiveness
(an improvement in the terms of trade of a country will decrease their competitiveness as
their exports will become more expensive)
(a deterioration in the terms of trade of a country will increase their competitiveness as
their exports are cheaper)
Increased competitiveness → increased exports → Increased AD → Increased Real
GDP
Increased competitiveness → increased exports → Increased AD → increased demand
for labour → increased employment
Increased competitiveness → increase in exports → Increased AD → increase in export
revenue → improve the current account deficit
THE OPPOSITE IS ALSO TRUE
Restrictions on Free Trade
Free trade: International trade without any barriers, restrictions
Specialisation and Trade
● Comparative advantage: Lower opportunity cost of producing a good or service
● Theory of comparative advantage: Global output will increase if countries specialise in
goods in which they have a comparative advantage.
Assumptions and limitations of the theory of comparative advantage
Assumption: The average cost of production remains constant
Limitation: Increased specialisation might result in higher average costs due to diseconomies
of scale
Assumption: There are no trade barriers
Limitation: There are trade barriers such as tariffs. Trade barriers might distort comparative
advantage
Assumption: There are no transport costs
Limitation: Real life transport costs might distort comparative advantage
Advantages and disadvantages of specialisation and trade in the real world
Advantage: Increase in global output and therefore an increase in living standards
Disadvantage: Benefits of specialisation and trade are based on unrealistic assumptions
(above).
Advantage: Access to larger markets can lead to economies of scale
Disadvantage: Might lead to an over dependence on imports and exports
Advantage: Leads to lower prices and more choice for consumers
Disadvantage: Increased specialisation can lead to decreased motivation, decreasing
productivity, and increasing prices as a result. (Demotivation due to ABC: Alienation,
Bureaucracy, Poor Communication)
Globalisation
Globalisation: The increased integration of different economies around the world
, 5 Characteristics of Globalisation
1. Increased international movement of labour
2. Increased international movement of financial capital
3. Increased specialisation
4. Increase in international trade
5. Increase in trade to GDP ratios
Trade to gdp ratios: (Total value of trade / GDP) * 100
4 Causes of Globalisation
1. Improvements in transportation (more available + cheaper)
2. Improvements in IT (the Internet, making the international movement of financial capital
easier)
3. Improvements in shipping such as containerisation (increasing the volume of
international trade, cheaper, more convenient)
4. Trade liberalisation (removal of trade barriers, eg. removal/decrease in tariffs)
Impacts of Globalisation
On Countries:
Advantage: Increased living standards caused by higher global output
Disadvantage: Might lead to an over dependence on imports and exports
On Governments:
Advantage: Increased tax revenue from increased output (corporation tax)
Disadvantage: Increase in transfer pricing (tax avoidance)
On Producers:
Advantage: Lower costs due to relocation to countries with lower wages
Disadvantage: Higher barriers of entry set up by TNCs (transnational corporations). TNCs can
achieve economies of scale with access to larger markets (eg. purchasing economies of scale,
bulk buy)
On Consumers:
Advantage: Lower prices and more choice
,Disadvantage: Consumers being driven to consume more can reduce consumer happiness
(Diderot effect)
On Workers:
Advantage: Increased international job opportunities (because of improvements in
transportation)
Disadvantage: Structural unemployment (Certain industries have been moved from developed
countries to developing countries due to lower costs, wages. Workers working in these
industries in developed countries have lost their jobs, no demand for their labour, their skills
don’t match the skills in demand)
Remittances: Money sent by a foreign worker to an individual in their home country (have
increased as a result of globalisation)
On the Environment:
Advantage: Increased cooperation between countries to tackle climate change
Disadvantage: Increased production → Negative externalities of production → Increased
pollution → Increase in global warming
Terms of Trade
Terms of trade: Relationship between the price of exports and the price of imports
Terms of trade ratio: (Index of export prices / index of import prices) * 100
Export prices increase relative to import prices → terms of trade have improved
Export prices decrease relative to import prices → terms of trade have deteriorated
4 Factors Impacting the Terms of Trade
1. Raw material prices (for exporting countries: increase in raw material prices → increase
in index of exports → improvement in terms of trade, opposite is true for importing
countries, and vice versa)
2. Tariffs (tax paid on imports) (adding/increasing tariffs → increase index of imports →
deteriorate terms of trade
, decreasing/removing tariffs → decrease in index of imports → improvement in terms of
trade)
3. Exchange rates (if a country’s currency appreciates → increase in index of exports and
decrease in index of imports → their terms of trade will improve, and vice versa)
4. Inflation rates (inflation: sustained increase in the general price level)
If a country’s inflation rate is lower than that of its trading partners then its index of import
prices will be rising more than its index of export prices. Therefore its terms of trade will
deteriorate. (the opposite is true)
Impact of Changes in a Country’s Terms of Trade
1. Living Standards (improvement of terms of trade will improve living standards,
deterioration of terms of trade will shrink living standards)
2. Competitiveness
(an improvement in the terms of trade of a country will decrease their competitiveness as
their exports will become more expensive)
(a deterioration in the terms of trade of a country will increase their competitiveness as
their exports are cheaper)
Increased competitiveness → increased exports → Increased AD → Increased Real
GDP
Increased competitiveness → increased exports → Increased AD → increased demand
for labour → increased employment
Increased competitiveness → increase in exports → Increased AD → increase in export
revenue → improve the current account deficit
THE OPPOSITE IS ALSO TRUE
Restrictions on Free Trade
Free trade: International trade without any barriers, restrictions
