IB Economics SLTopic 4 — The Global EconomyPaper 1 & 2Core idea~9 min read
Why Countries Trade
Trade happens because countries are not equally good at making everything. One has the climate, another the skills, another the machinery. Open the border and each country does more of what it is relatively best at, and everyone gets more for the same resources. That is the argument. The interesting part is who actually gains.
📘 What you need to know
International trade is the exchange of goods and services between countries, through exports and imports.
Trade is free when governments do not use taxes, quotas or rules to limit it.
The main gains: lower prices, more choice, access to resources, bigger markets, more efficient firms, new ideas and technology, growth and development.
Whether a country imports or exports a good depends on the world price compared with its own domestic price.
If the world price is below the domestic equilibrium price, the country imports the difference.
If the world price is above it, domestic firms sell abroad and the country exports the difference.
Trade makes a country better off overall, but producers and consumers are affected in opposite directions, which is where the politics starts.
What free trade actually buys you
The list of benefits is long, but they all come from the same root: trade lets each country specialise. Once you stop trying to make everything yourself, your resources go into what you do well, and you buy the rest more cheaply than you could have made it.
Benefit
Why it happens
Who feels it first
Lower prices
Foreign competition undercuts domestic firms
Consumers, and firms buying inputs
Greater choice
Goods that are not made at home become available
Consumers
Access to resources
Raw materials a country does not have can be bought
Manufacturers
Economies of scale
Firms sell to a world market, so output per firm rises
Exporting firms
Greater efficiency
Firms that cannot compete must improve or leave
The whole economy, over time
Flow of ideas
Technology and methods travel with the goods
Producers in poorer countries
Growth and development
Exports add to GDP; higher output raises incomes
The economy as a whole
Notice the last column. Almost every gain from trade lands on a different group from the losses, and that is why free trade is economically popular and politically difficult. Bring this up in evaluation and you are already thinking like an examiner wants.
The world price decides everything
A single diagram answers the whole question. Draw the domestic market, then draw the world price as a horizontal line, because a small country can buy or sell as much as it likes at that price without moving it. Where that line sits compared with the domestic equilibrium tells you whether the country becomes an importer or an exporter.
Sd is domestic supply and Dd is domestic demand. The world price is drawn flat because one small country buying wheat cannot shift the world market.
WORKED EXAMPLE
Using the diagram, calculate the quantity of imports and the amount spent on them. [4]
Step 1: read the two quantities at the world price
At $20, domestic supply is 40,000 tonnes and domestic demand is 120,000 tonnes.
Step 2: imports are the gap between them120,000 − 40,000 = 80,000 tonnesStep 3: spending is price × quantity$20 × 80,000 = $1,600,00080,000 tonnes imported, costing $1.6mRead both quantities off the world price line, never off the old equilibrium. That single slip is the most common error on this diagram.
The same market, the other way round
Now suppose the world price for this crop is above what the domestic market would settle at. Domestic firms would rather sell abroad, so the price at home is pulled up to the world price. Producers expand, domestic consumers buy less, and the surplus is exported.
Exactly the same curves. Only the height of the world price line has changed, and with it the direction of trade.
WORKED EXAMPLE
Using the second diagram, calculate the quantity of exports and the export revenue earned. [4]
Step 1: read both quantities at the world price of $40
Domestic supply is 120,000 tonnes; domestic demand is 40,000 tonnes.
Step 2: exports are the excess supply120,000 − 40,000 = 80,000 tonnesStep 3: revenue is world price × quantity exported$40 × 80,000 = $3,200,00080,000 tonnes exported, earning $3.2mExport revenue uses only the exported quantity. Multiplying by total output (120,000) is a different number and a different question.
One diagram, two answers. If you can draw this market once and slide the world price line up and down, you can answer most 4-mark trade questions in Paper 2 without learning anything new.
Who gains and who loses
Overall gains from trade are real, but they are never spread evenly, and part b questions live on exactly this point.
This asymmetry is the whole political story of trade policy, and it is the strongest evaluation point you can make in a free trade essay.
💡 Exam tip
Draw the world price as a flat line. A small country is a price taker, so it can trade any quantity at that price.
Label Qs and Qd separately on the world price line. Imports or exports are always the gap between them.
Say which direction trade goes and why in one sentence: world price below domestic price means imports.
Keep the units. If quantity is in thousands of tonnes, your revenue answer is in thousands of dollars unless you convert.
For evaluation, name the losers. “Consumers gain but domestic producers in that industry lose sales” is worth more than a list of benefits.
Use one real example of a country that opened up and what happened to its prices, jobs or exports.
⚠️ Common mix-up
Reading quantities off the old equilibrium instead of off the world price line. Once trade opens, the domestic equilibrium no longer sets output.
Thinking imports mean the country is doing badly. Imports are the goods people actually wanted at a price they could afford.
Confusing exports with export revenue. One is a quantity, the other is price times that quantity.
Assuming free trade helps everyone at once. It raises total welfare, which is not the same thing.
Drawing the world price line sloping. For a small country it is horizontal; that is the whole point of being a price taker.
Forgetting that firms are consumers too. Cheaper imported steel is a cost saving for every factory that uses steel.
Up next: Tariffs and Quotas — what happens to this same diagram when a government decides it does not like the level of imports.
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