Specialisation: a country concentrates on producing the goods and services for which it has a comparative advantage – i.e. the lowest opportunity cost.
Comparative advantage: a country can produce a good at a lower opportunity cost than another country, even if it is less efficient in absolute terms.
Free‑trade: removal of all barriers (tariffs, quotas, licences, subsidies, etc.) so that goods and services can move between countries without restriction.
Advantages of specialisation and free‑trade
Higher overall output – resources are used where they are most productive.
Consumers enjoy a larger variety of goods at lower prices.
Countries can earn foreign exchange by exporting surplus production.
Technology and ideas spread more quickly (knowledge spill‑overs).
Disadvantages / arguments against free‑trade
Dependence on imports for essential goods can create vulnerability (e.g., food, energy).
Domestic industries that are not internationally competitive may shrink, leading to job losses and regional decline.
Developing countries may find it hard to move up the value chain if they are locked into low‑value exports.
Environmental and labour standards can be undermined when production moves to countries with weaker regulations.
Example: Country A has a comparative advantage in coffee, Country B in electronics. By specialising, A exports coffee and imports electronics; both enjoy more coffee and cheaper phones than if they tried to produce both goods themselves.
Globalisation
Definition (syllabus wording): the increasing integration of world economies through the growth of international trade, the movement of capital and labour, and the spread of ideas and technology.
Key drivers of change
Lower transport costs – containerisation, larger ships, cheaper air freight.
Lower communication costs – internet, mobile phones, satellite links.
Growth of multinational corporations (MNCs).
Liberalisation of trade and investment policies (e.g., removal of tariffs, free‑trade agreements).
Technological innovation – automation, digital platforms, e‑commerce.
Multinational corporations (MNCs)
Definition: a firm that owns or controls production facilities in more than one country.
Advantages: access to larger markets, economies of scale, spread of technology, job creation in host countries.
Disadvantages: can dominate local markets, repatriate profits, may exert pressure on governments to lower standards.
Reasons governments impose trade restrictions
Protect infant industries that need time to become competitive.
Counter dumping – protect domestic producers from goods sold below cost.
Maintain balance of payments stability.
Safeguard national security (e.g., weapons, critical infrastructure).
Protect the environment, health, or public morals (e.g., bans on hazardous chemicals).
Preserve cultural heritage or domestic employment.
Evaluation of trade restrictions
Positive effects
Negative effects
Supports new industries; protects jobs; can improve trade balance; allows time to improve standards.
Raises prices for consumers; can provoke retaliation; creates inefficiency and dead‑weight loss; may breach WTO rules.
Trade Restrictions – Methods of Protection
Governments may intervene in international trade for a range of policy objectives. The main protectionist tools covered by the IGCSE syllabus are:
Tariffs (import duties)
Quotas (quantitative limits on imports)
Import licences (authorisations required before goods can be brought in)
Export subsidies (payments to exporters)
Domestic subsidies (payments to domestic producers)
Anti‑dumping duties (tariffs imposed to counter selling below cost)
Subsidies
A subsidy is a financial contribution made by the government to a firm, industry or individual that reduces the cost of producing a good or service, or raises the price received for it. By lowering the effective marginal cost, a subsidy encourages higher output and can make domestic goods more competitive in international markets.
Types of subsidies
Type
Who receives it?
Primary objective
Typical example
Potential drawbacks
Production subsidy
Domestic producers
Increase output & domestic supply
$ 20 / tonne of wheat
Over‑production, fiscal burden, WTO disputes
Export subsidy
Exporting firms
Make exports cheaper abroad
Aircraft manufacturers receive $ per aircraft
Retaliation, distortion of world prices, WTO violations
Input subsidy
Firms using the subsidised input
Reduce production costs
Fuel tax rebate for transport companies
Encourages use of subsidised inputs, possible environmental harm
Price‑support subsidy
Producers of the supported good
Stabilise incomes of farmers
Minimum price for milk with government buying surplus
Government stockpiles, higher consumer prices, market distortion
Tax rebate / credit
Firms meeting policy criteria
Encourage specific activities (e.g., R&D)
R&D tax credit for technology firms
Complex administration, may favour larger firms
Economic effects of a production subsidy
In a domestic market the supply curve faced by producers shifts downwards (or to the right) by the amount of the subsidy per unit.
Supply‑demand diagram (not drawn) – original supply S, subsidised supply S′ (parallel shift down by s). New equilibrium: lower price P′, higher quantity Q′. Shaded areas show changes in consumer surplus (CS), producer surplus (PS), government expenditure (GE) and dead‑weight loss (DWL).
Welfare impacts
Consumer surplus rises because the market price falls.
Producer surplus rises because producers receive the market price plus the subsidy.
Government cost = subsidy per unit (s) × quantity produced (Q′).
Dead‑weight loss results from over‑production relative to the free‑market equilibrium.
Calculating the cost of a production subsidy
If the subsidy is s dollars per unit and the subsidised quantity produced is Q′, then
Government Expenditure = s × Q′
Example: A wheat subsidy of $ 20 per tonne raises domestic output from 1 000 tonnes to 1 300 tonnes.
Cost = 20 × 1 300 = $ 26 000
Key points for revision
Subsidies lower the effective cost of production, shifting the supply curve outward.
Both consumer and producer surplus increase, but the government bears a fiscal cost.
Over‑production creates a dead‑weight loss – a loss of total welfare.
Internationally, subsidies can breach WTO rules and provoke retaliatory measures.
When answering exam questions, discuss:
Short‑run effects on price and quantity.
Long‑run welfare implications (CS, PS, government cost, DWL).
Possible trade‑policy consequences (e.g., disputes, retaliation).
Foreign‑Exchange Rates
Definition: the price of one currency expressed in terms of another (e.g., £1 = $1.30).
Floating (flexible) rate: determined by supply and demand in the foreign‑exchange market; can appreciate or depreciate.
Fixed (pegged) rate: government or central bank sets the rate and intervenes to maintain it.
Determinants of exchange rates (floating system)
Relative inflation rates – higher inflation in a country tends to depreciate its currency.
Current‑account balance – a surplus (more exports than imports) creates demand for the domestic currency, leading to appreciation.
Speculative expectations – expectations of future movements can cause immediate shifts.
Effects of appreciation and depreciation
Change
Effect on imports
Effect on exports
Impact on domestic consumers
Appreciation
Cheaper – imports rise
More expensive abroad – exports fall
Consumers benefit from lower prices of foreign goods.
Depreciation
More expensive – imports fall
Cheaper abroad – exports rise
Consumers pay more for imported goods.
Simple supply‑demand diagram (description)
Horizontal axis: quantity of domestic currency; vertical axis: price in foreign currency. A rightward shift of demand (higher foreign demand) leads to appreciation; a leftward shift leads to depreciation.
Current Account of the Balance of Payments
The current account records a country’s transactions in goods, services, primary income (e.g., wages, investment income) and secondary income (e.g., remittances, aid).
Components
Component
What it records
Goods (trade balance)
Exports minus imports of tangible products.
Services
Exports minus imports of tourism, transport, financial services, etc.
Primary income
Investment income (interest, dividends) and compensation of employees received from abroad minus similar payments made abroad.
Secondary income
Transfers such as remittances, foreign aid, and pensions received minus those paid out.
Calculating the current‑account balance
Current‑account balance = (Exports of goods + Exports of services + Primary income received + Secondary income received) – (Imports of goods + Imports of services + Primary income paid + Secondary income paid)
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