CFA Level I Exam · International Trade

Trade Patterns and Models of Trade for CFA Level I

Updated 7 October 2026 · Fact-checked

Trade models explain why countries trade and who gains. Ricardian: differences in labor productivity. Heckscher-Ohlin: differences in capital and labor endowments. Specific factors: some factors cannot move between industries in the short run. Economies of scale explain intra-industry trade. Terms of trade is the export price divided by the import price.

Understand Trade Patterns and Models of Trade

Imports are goods and services a country buys from abroad. Exports are what it sells abroad. A country with free trade has no restrictions on either. Autarky means no trade at all. The terms of trade is the ratio of an index of export prices to an index of import prices. If it rises, each unit of exports buys more imports, so the country is usually better off.

The Ricardian model has one factor of production: labor. Countries differ in labor productivity (technology). Each country exports the good in which it has a comparative advantage, meaning the lower opportunity cost. Its weakness: it explains trade only by technology and predicts full specialization, which rarely happens.

The Heckscher-Ohlin (HO) model has two factors, capital and labor, both mobile between industries. Technology is the same everywhere. Countries differ in factor endowments. A country exports the good that uses its relatively abundant factor intensively, and imports the good that uses its relatively scarce factor. A capital-rich country exports capital-intensive goods. With trade, the owners of the abundant factor gain and the owners of the scarce factor lose in the long run. The overall country still gains.

The specific-factors model has labor, which is mobile across industries, plus at least two specific factors, one for each industry (for example, capital in manufacturing and land in agriculture). Specific factors cannot move between industries in the short run. When trade opens, the owners of the specific factor in the export industry gain, and owners of the specific factor in the import-competing industry lose. Labor is mixed: its real wage rises in terms of one good and falls in terms of the other, so the effect is ambiguous. Compare with HO: HO is long run, specific factors is short run.

The models above explain inter-industry trade, where countries swap different goods. Much real trade is intra-industry trade: a country both exports and imports goods of the same industry, such as cars between Germany and Japan. It is explained by economies of scale (average cost falls as output rises, so each country specializes in some varieties) and by product differentiation, where consumers like variety. This is why trade is large between similar, rich countries. Economies of scale can be internal (the firm grows) or external (the industry clusters in one place).

Key formulas to remember

Terms of trade: Terms of trade = Index of export prices ÷ Index of import prices; A rise means each unit of exports buys more imports. A rise is generally favorable.
Ricardian rule: Export the good with the lower opportunity cost (comparative advantage); Based on relative labor productivity, not absolute productivity.
Heckscher-Ohlin rule: Export goods that use the abundant factor intensively; import goods that use the scarce factor intensively; Assumes identical technology and two mobile factors, capital and labor.
Specific-factors rule: Short run: owners of the specific factor in the export sector gain; in the import-competing sector lose; mobile labor is ambiguous; Capital is fixed to its industry in the short run.
Trade measure: Trade openness = (Exports + Imports) ÷ GDP; A common indicator of how large trade is relative to the economy.

How to solve Trade Patterns and Models of Trade questions

Use this order for any question on trade patterns or trade models.

1Identify what the question asks: pattern of trade, winners and losers, or the cause of trade.
2Find the model by its clue: only labor and productivity means Ricardian; capital and labor endowments means Heckscher-Ohlin; a fixed or industry-specific factor means specific factors; similar countries trading the same industry's goods means economies of scale.
3For Ricardian questions, compute opportunity costs for each good in each country and compare. The lower one wins.
4For HO questions, decide which factor is abundant, then which good is intensive in it. Abundant-factor goods are exported.
5For winners and losers, ask who owns the abundant (or export-sector) factor. They gain. The owners of the scarce (or import-competing) factor lose.
6For terms of trade, divide export price index by import price index and judge the direction of change.
7Eliminate options that mix models, such as giving a Ricardian reason for an HO result.

Quickest way: Clue-word model matching

When to use it: When you have about 90 seconds and the question asks which model or which outcome applies.

Scan the stem for the clue: technology or productivity, endowments, short run or specific, scale or variety.
Match to the model: technology is Ricardian, endowments is HO, short run fixed factor is specific factors, scale or variety is intra-industry trade.
Apply the one-line rule for that model and pick the option that follows it.
If two options remain, check the time frame: long run points to HO, short run to specific factors.

Common mistakes in Trade Patterns and Models of Trade

Saying HO explains trade by differences in technology.
Students mix up Ricardian and HO, because both explain comparative advantage.
Fix: Ricardian means technology differs. HO means technology is the same and endowments differ.
Using absolute productivity to decide who exports what.
It feels natural that the more productive country exports everything.
Fix: Compare opportunity costs. The country exports the good where its opportunity cost is lower, even if it is less productive in both goods.
Claiming all labor gains from trade in the specific-factors model.
Students remember that labor is mobile and assume it benefits.
Fix: Labor's outcome is ambiguous. Its real wage rises in terms of one good and falls in terms of the other.
Thinking a rising terms of trade always means more exports sold.
The word 'favorable' is read as a volume effect.
Fix: Terms of trade is a price ratio. A rise means exports buy more imports, but says nothing alone about volumes.
Explaining intra-industry trade with comparative advantage in factors.
Students apply HO to every trade flow.
Fix: Intra-industry trade comes from economies of scale and product differentiation, especially between similar countries.
Treating the abundant factor as the one with the higher total amount.
Abundance is read as absolute size.
Fix: Abundance is relative: compare the capital-to-labor ratio across countries.

Worked examples

Example 1

In one hour, Country X can produce 6 units of wine or 3 units of cloth. Country Y can produce 2 units of wine or 2 units of cloth. Which statement is correct? A. X has a comparative advantage in cloth. B. X has a comparative advantage in wine. C. Y has a comparative advantage in wine.

Show the solution

Opportunity cost of 1 wine in X = 3 ÷ 6 = 0.5 cloth.
Opportunity cost of 1 wine in Y = 2 ÷ 2 = 1 cloth.
X gives up less cloth for wine, so X has a comparative advantage in wine.
Check cloth: X gives up 2 wine per cloth, Y gives up 1 wine per cloth. Y has the advantage in cloth.
A is wrong because Y, not X, has the advantage in cloth; C is wrong because Y gives up more cloth per wine.

Answer: B. X has a comparative advantage in wine.

Example 2

Country A is capital-abundant and labor-scarce. Under the Heckscher-Ohlin model, after moving from autarky to free trade, which outcome is expected in the long run? A. Owners of capital lose and workers gain. B. Owners of capital gain and workers lose. C. Both owners of capital and workers lose.

Show the solution

A is capital-abundant, so it exports capital-intensive goods.
Demand for the abundant factor, capital, rises, so its return rises.
Labor is the scarce factor, so its return falls.
The country as a whole still gains, but not every group does, so option C is wrong.
Option A reverses the result: owners of the abundant factor (capital) gain, so A is wrong.

Answer: B. Owners of capital gain and workers lose.

Exam tips

Questions often ask you to name the model from a short description. Learn the one clue for each.
Winner and loser questions are common. Ask who owns the abundant or export-sector factor.
Remember the time frame: HO is long run with mobile factors, specific factors is short run.
For terms of trade, read carefully whether export or import prices moved, then judge the ratio.
Intra-industry trade questions point to economies of scale and differentiated products, not factor endowments.

Practice questions from International Trade

Trade Patterns and Models of Trade: frequently asked questions

What is the Heckscher-Ohlin model in CFA Level I?

It says countries export goods that use their abundant factor intensively and import goods that use their scarce factor. It assumes two factors, capital and labor, both mobile, and the same technology everywhere.

What is intra-industry trade with an example?

It is two-way trade in similar goods within one industry. Germany and Japan both export and import cars. It comes from economies of scale and consumer taste for variety.

How does the specific-factors model differ from Heckscher-Ohlin?

Specific factors is a short-run model where capital is tied to one industry and only labor moves. HO is long run with all factors mobile. Specific factors gives clear winners and losers among capital owners, with ambiguous results for labor.

What does terms of trade mean and what are its effects?

It is the ratio of export prices to import prices. When it rises, a country can buy more imports per unit of exports, which generally improves welfare. When it falls, the reverse holds.