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Theory of Trade


The growing integration of the world's economy where business increasingly produce all or
part of their raw materials in the cheapest parts of the world and increasingly, market their
products on a worldwide basis. A business may make parts for a product in several different

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Some multinationals have demanded subsidies to move to areas of structural
unemployment, or threatened to move elsewhere
Increased job insecurity in large movable companies e.g. manufacturing firms who
have been able to move abroad. This impacts confidence, affecting consumption and

The theory underlying international trade

International trade is…

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Comparative advantage exists when the opportunity cost is the lowest.
E.g. If one country X can produce 1 apple and 2 bananas, and another country Y produces 1
apple and 3 bananas, country X is the better producer. This is because it has to give up less
to produce bananas.…

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If country Y gave up 40 wheat, it would produce 10 machines, and vice versa. To determine
the OC for wheat, we would need to divide 10 by 40, which is 0.25. For every wheat that we
produce, we give up 0.25 machine.

Therefore, country Y has a comparative advantage…

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Worked example of comparative advantage
Consider two countries producing two products ­ digital cameras and vacuum cleaners.
With the same factor resources evenly allocated by each country to the production of both
goods, the production possibilities are as shown in the table below.
Prespecialisation Digital Cameras Vacuum Cleaners
UK 600…

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Total 3360 1800

Compared with the prespecialisation output levels, consumers in both countries now have
an increased supply of both goods to choose from.
Is trade really beneficial?

The period since WW2 has seen a great movement towards the freeing of trade. This has
been championed by nations such as…

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The index is calculated by:

In the base year, all the index numbers will be 100, and so the overall terms of trade index will
be 100. If the terms of trade index rise to 110, this means that 10% more imports can be
gained from the same amount of…

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Extra reading on TOT

Improvement in TOT
More imports are received for a given number of exports ­ for this to happen, export
prices will need to rise while import prices will need to fall
The effect of this improvement in the TOT on the total amount spent on imports…

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The problems intensified in 1998 with the collapse in the currencies of many Asian
developing countries. A big fall in the terms of trade signifies a reduction in real living
standards since imports of goods and services have become relatively more expensive.

Other points to note:
Improvements in TOT can…

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Factors determining comparative advantage

The quantity and quality of factors of production available (e.g. the size and efficiency
of the available labour force and the productivity of the existing stock of capital inputs).
If an economy can improve the quality of its labour force and increase the stock of




This is a 9 page well written summary on the reasons for globalisation and reasons for trade. It is an excellent resource for producing your own revision documents from or for reading and learning if you are able to do this.



awsum <3 <3 

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