Why countries trade

Countries gain by specialising in what they produce relatively best and trading for the rest. Comparative advantage means producing a good at a lower opportunity cost than another country.

Gains from trade include: greater world output, lower prices, more variety, economies of scale and access to resources a country lacks.

Key concept — interdependence: specialisation makes economies reliant on each other, which raises living standards but also spreads shocks.

The gain from trade

Free trade vs protectionism

Governments sometimes restrict trade to protect domestic industries or jobs. The main tools are:

• Tariff — a tax on imports, raising their price.
• Quota — a physical limit on the quantity of a good that can be imported.
• Subsidy — a payment to domestic producers, lowering their costs so they can undercut imports.

Costs of protection: higher prices for consumers, inefficiency, welfare loss and risk of retaliation, even if some domestic jobs are protected.

Which protectionist tool?

Tap a description, then tap the tool it describes.

Exchange rates

An exchange rate is the price of one currency in terms of another. In a floating system it is set by demand for and supply of the currency.

• Appreciation — the currency rises in value: exports become dearer abroad, imports cheaper at home.
• Depreciation — the currency falls in value: exports cheaper, imports dearer.

Your turn — currency conversion

A stronger currency

The balance of payments

The balance of payments records all transactions between a country and the rest of the world. Its main parts are:

• Current account — trade in goods and services, primary income (investment income) and secondary income (transfers).
• Capital and financial account — flows of investment and financial assets.

A current account deficit is largely offset by surpluses on the financial account (e.g. inward investment).

Trade balance: value of exports − value of imports. A negative figure is a deficit.

Your turn — trade in goods

The terms of trade

The terms of trade measure the ratio of a country’s export prices to its import prices, expressed as an index:

An improvement (a rise in the index) means each unit of exports buys more imports. It can come from higher export prices or lower import prices.

Your turn — terms of trade

Reading the index

Economic integration

Countries cooperate through deeper stages of integration:

• Free trade area — no tariffs between members.
• Customs union — free trade plus a common external tariff.
• Common market — adds free movement of factors (labour and capital).
• Monetary union — members share a single currency and monetary policy.

Trade-off: integration brings larger markets and efficiency but reduces national policy independence.

Match each term to its definition

Tap a definition on the left, then the term on the right.

Measuring economic development

Growth is a rise in output; development is a broader improvement in living standards and freedoms. Because no single figure captures it, we use composite measures.

The Human Development Index (HDI) combines three dimensions:

• Health — life expectancy at birth.
• Education — mean and expected years of schooling.
• Income — GNI per capita.

Single vs composite: single indicators (e.g. GDP per capita) are easy but narrow; composite indicators like HDI give a fuller picture.

Inside the HDI

Barriers to development & sustainability

Common barriers to development include poverty traps, low savings and investment, poor infrastructure, weak institutions and governance, heavy dependence on primary exports, and high debt.

Sustainable development meets present needs without compromising the ability of future generations to meet theirs — balancing growth with environmental protection and equity.

Strategies: investment in human capital and infrastructure, trade, foreign direct investment, aid, and micro-finance can all support development.

Your turn — imports after appreciation

The big ideas to know

You have covered the core of the IB global economy unit. Press Finish to see your score.