Trade Theories and Patterns

International trade is a fundamental driver of globalisation and a key mechanism through which countries participate in the global economy. Understanding trade theories, patterns, and the institutions that govern trade is essential for AQA A-Level Geography.

Key Definition: International trade is the exchange of goods, services, and capital between countries. It is shaped by comparative advantage, government policies, and the rules established by international organisations such as the WTO.

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Absolute Advantage

The theory of absolute advantage was developed by Adam Smith in The Wealth of Nations (1776).

Core Principle

A country has an absolute advantage when it can produce a good using fewer resources (land, labour, capital) than another country.

Example:

• Brazil can produce coffee more cheaply than the UK due to its tropical climate and suitable soils
• The UK can produce financial services more cheaply than Brazil due to its established institutions and skilled workforce
• Both countries benefit if Brazil exports coffee to the UK and the UK exports financial services to Brazil

Limitations

• It does not explain what happens when one country is more efficient at producing everything
• This limitation led David Ricardo to develop the theory of comparative advantage

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Comparative Advantage

David Ricardo's theory of comparative advantage (1817) argues that countries should specialise in producing goods where they have the lowest opportunity cost, even if they do not have an absolute advantage.

Core Principle

Even if Country A can produce both wine and cloth more efficiently than Country B, trade is still beneficial if Country A specialises in the good where its relative advantage is greatest.

Country	Wine (units/hour)	Cloth (units/hour)	Comparative Advantage
Portugal	10	5	Wine (ratio 2:1)
England	4	3	Cloth (ratio 1.33:1)

Portugal should specialise in wine (where its advantage is greatest), and England should specialise in cloth (where its disadvantage is least). Both countries benefit from trade.

Real-World Application

• Bangladesh specialises in garment manufacturing — low labour costs give it a comparative advantage despite limited technology
• Germany specialises in high-value engineering and automotive production — skilled workforce and advanced technology
• Saudi Arabia specialises in oil — vast reserves give it an overwhelming comparative advantage in energy

Criticisms of Comparative Advantage

• Assumes perfect competition and free trade, which rarely exist in practice
• Ignores transport costs, which can eliminate theoretical gains from trade
• Does not account for economies of scale — larger countries may have advantages that theory does not predict
• Can lead to over-specialisation and vulnerability to price shocks (e.g., commodity-dependent economies)
• Ignores power imbalances between developed and developing countries in setting terms of trade

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Terms of Trade

The terms of trade measure the ratio of export prices to import prices for a country.

Calculating Terms of Trade

Terms of Trade = (Index of Export Prices / Index of Import Prices) × 100

• If the index is above 100, the terms of trade are favourable — export prices are rising relative to import prices
• If below 100, terms of trade are unfavourable — a country must export more to pay for the same volume of imports

The Prebisch-Singer Hypothesis

Raul Prebisch and Hans Singer argued that the terms of trade for primary commodity exporters tend to decline over time relative to manufactured goods exporters. This means:

• Countries dependent on exporting raw materials (coffee, cocoa, copper) face declining purchasing power
• Industrialised nations that export manufactured goods enjoy improving terms of trade
• This contributes to the development gap between the Global North and Global South

Case Study: Zambia's dependence on copper exports illustrates this problem. When copper prices fell sharply in 2015-16, Zambia's terms of trade deteriorated, government revenues dropped, and the kwacha lost over 40% of its value against the US dollar.

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Trade Blocs

Trade blocs are groups of countries that have agreed to reduce or eliminate trade barriers between them.

Types of Trade Bloc

Type	Features	Example
Free Trade Area	No tariffs between members; each sets own external tariffs	USMCA (formerly NAFTA)
Customs Union	No internal tariffs; common external tariff	Mercosur
Common/Single Market	Customs union plus free movement of labour and capital	EU Single Market
Economic Union	Single market plus harmonised economic policies	Eurozone

European Union (EU)

• The world's largest single market with 27 member states and approximately 450 million consumers
• Free movement of goods, services, capital, and people within the single market
• Common Agricultural Policy (CAP) provides subsidies to European farmers
• The Eurozone (20 members by 2023) shares a single currency, the euro
• Critics argue that the EU imposes high external tariffs on agricultural imports from developing countries, harming their export prospects

USMCA (formerly NAFTA)