Absolute and comparative advantage, opportunity cost ratios from two PPFs, how specialisation and trade at terms between the two opportunity costs let both countries consume beyond their frontiers, and the wider benefits and costs of free trade. Through the UK–India trade agreement.
On 15 July 2026 the UK–India trade agreement came into force, almost a year after it was signed. India cut its tariff on Scotch whisky from 150% to 75% at once, falling to 40% over ten years, and cut tariffs on British cars, medical devices and machinery. The UK gave duty-free access to 99% of India’s tariff lines: clothing, footwear, jewellery, food. The UK government expects trade between the two to rise by £25bn a year in the long run.
So the UK will sell India more whisky and machines, and India will sell the UK more shirts and shoes. Each will make less of what the other now supplies. Workers in Leicester garment factories and Indian distilleries will feel it.
Why do economists expect both countries to gain, and who inside each country loses?
Source: Department for Business and Trade, UK–India Comprehensive Economic and Trade Agreement, in force 15 July 2026; Scotch Whisky Association, 17 June 2026.
A country has an absolute advantage in a good if it can make more of it with the same resources than another country.
A country has a comparative advantage in a good if it can make it at a lower opportunity cost, giving up less of other goods, than another country.
The law of comparative advantage (David Ricardo, 1817): if countries specialise in the goods in which they have a comparative advantage and trade, total output rises and both can consume more than they could alone, even if one country has an absolute advantage in everything.
The terms of trade are the rate at which exports exchange for imports. For trade to benefit both, the rate must lie between the two countries’ opportunity costs.
Assumptions behind the simple model: two countries, two goods, constant opportunity costs (straight-line PPFs), no transport costs, factors mobile within a country but not between them.
In a day the UK can make 40 machines or 80 shirts. India can make 10 machines or 120 shirts.
The UK is better at making machines. India is better at making shirts. Suppose instead the UK were better at both: 40 machines or 200 shirts.
Would the UK still gain from trading with India?
Trade is about opportunity cost, not about who is better. If a machine costs the UK 5 shirts and costs India 12, the UK should make machines and India shirts, and both end up with more. That is comparative advantage, and it is the most counter-intuitive idea in economics.
Two countries, two goods. With all its resources for a day the UK makes **40 machines or 80 shirts**, or any mix on its PPF. India makes **10 machines or 120 shirts**. The UK has the absolute advantage in machines; India in shirts. That already suggests who should make what, but absolute advantage is not the test.
Check: In this example, which country has an absolute advantage in making machines?
Absolute advantage is about output from the same resources. The UK makes four times as many machines.
Opportunity costs come from the slopes. A machine costs the UK 80 ÷ 40 = 2 shirts. A machine costs India 120 ÷ 10 = 12 shirts. Turn it round: a shirt costs the UK half a machine and India one-twelfth of a machine. Before trade, say the UK makes 40 shirts and 20 machines (A) and India 60 shirts and 5 machines (B).
Teacher tip: Students often compare outputs instead of opportunity costs. Write the ratios out every time: “one machine costs X shirts” for each country. The lower number has the comparative advantage.
Check: What is the opportunity cost of one machine in India?
India gives up 120 shirts to make 10 machines: 120 ÷ 10 = 12 shirts per machine. The UK gives up 80 ÷ 40 = 2.
Comparative advantage: the UK makes machines more cheaply in shirts forgone (2 against 12), India makes shirts more cheaply in machines forgone (1/12 against 1/2). So each specialises: the UK moves to 40 machines and no shirts, India to 120 shirts and no machines. Total output was 100 shirts and 25 machines. Now it is **120 shirts and 40 machines**.
Check: Which country has the comparative advantage in shirts?
India gives up less to make a shirt, so it has the comparative advantage in shirts; the UK has it in machines, at 2 shirts against 12.
Now they trade. Suppose the terms of trade are 1 machine for 4 shirts: between 2 and 12, so both gain. The dotted lines show what each can now consume: the UK trades along a line from (0, 40) with slope 4 shirts per machine; India from (120, 0). Both lines lie **outside** the countries’ own PPFs.
Check: The terms of trade are 1 machine = 4 shirts. Why do both countries accept this rate?
The UK gets 4 shirts per machine, more than the 2 it could make itself. India gets a machine for 4 shirts instead of 12. Both are better off.
The UK sells 15 machines for 60 shirts and consumes at A2: 60 shirts and 25 machines, more of both than at A. India keeps 60 shirts and gains 15 machines: B2, (60, 15) against (60, 5). Each consumes at a point it could never reach alone. That is the gain from trade: a bigger pie, shared.
Check: The UK sells 15 machines to India for 60 shirts. After trade the UK consumes:
The UK makes 40 machines, sells 15 and keeps 25, and receives 60 shirts: (60, 25) against (40, 20) before. India keeps 60 shirts and gains 15 machines: (60, 15) against (60, 5).
Beyond the model, free trade brings lower prices and more choice for consumers, competition that forces domestic firms to improve, economies of scale from selling to a world market, and technology transfer. Export industries grow and create jobs: Scotch whisky expects to sell far more in India once the 150% tariff falls.
Check: Which of these is a benefit of free trade NOT captured by the two-good model?
The model shows output and consumption gains. Real trade also brings competition, variety, economies of scale from larger markets and the spread of technology.
The costs. Structural unemployment where the shrinking industry was concentrated: textile towns, steel towns. Dependence on imports for essentials, exposed when supply chains break, as in 2020–22. Infant industries that never get started against established rivals. Dumping and unfair competition. And the gains from trade are spread thinly across millions of consumers while the losses are concentrated and visible.
Check: A UK garment worker loses her job as cheaper Indian clothing enters duty-free. In economic terms this is:
Trade changes what a country makes. Workers in the industry that shrinks lose, and their skills may not transfer; consumers and export industries gain, but each only a little.
A is placed at 70 shirts and 30 machines, outside the UK’s PPF. Without trade a country cannot consume beyond what it can produce. Points outside the frontier are reachable only through trade.
Using the concept of comparative advantage, explain how the UK and India can both gain from the free trade agreement that came into force in 2026, and evaluate whether free trade benefits everyone in the UK.
Comparative advantage means producing a good at a lower opportunity cost than a trading partner: giving up less of other goods to make it. It is different from absolute advantage, which is making more with the same resources. The UK gives up relatively little to make whisky, pharmaceuticals, cars and machinery, where it has skilled labour and capital; India gives up relatively little to make clothing, footwear and textiles, where labour is plentiful and cheap.
If each specialises in the goods in which it has a comparative advantage, total output of both rises, because resources move to where they cost least in other goods forgone. Trading at terms of trade between the two countries’ opportunity costs then lets each consume a combination outside its own production possibility frontier. On a diagram with two straight-line PPFs, each country’s post-trade consumption point lies beyond its frontier, where it could not reach alone. The 2026 agreement works towards this by cutting India’s whisky tariff from 150% and removing UK tariffs on 99% of Indian goods, so prices move closer to the two countries’ true opportunity costs.
The gains go beyond the model. UK consumers get cheaper clothing and more choice; UK firms face competition that pushes them to improve; exporters such as the Scotch whisky industry reach a market of 1.4 billion people and can exploit economies of scale.
**However,** the gains are spread thinly across millions of consumers while the losses are concentrated. Garment workers in Leicester compete with duty-free imports and may face structural unemployment, since their skills do not transfer easily to the industries that grow. The simple model assumes constant opportunity costs and no transport costs, so in practice specialisation is partial and the gains smaller. Free trade makes the UK as a whole better off, so the winners could compensate the losers, but it benefits everyone only if they do: through retraining, regional support and a social security system that catches the people in the industries that shrink.
UK–India Comprehensive Economic and Trade Agreement: signed 24 July 2025, in force 15 July 2026; tariff figures from the Department for Business and Trade and the Scotch Whisky Association. The output figures on the diagram are invented, chosen so the arithmetic is clear. Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed.