July 6, 2017

International Trade Theory and Issues

International trade is going on for ages. There are conventional reasons for the existence for trade among kingdoms or nations.

Conventional Sources of international trade:

1. Diversity in conditions of production

Tropical reagions are suitable for certain products and temperate regions are suitable for certain other products.

2. Decreasing costs due to scale

Due economies of scale, a country which has taken lead in production of a product can increase scale of production and reduce costs further. Thus other countries may buy that product from this country lower cost of production.

3. Differences in tastes

The people of a country may have taste for a product and for the shortfall in the availability of their country may import from another country.

Unconventional Reason: The principle of comparative advantage

Each country will specialize in the production and export of those goods that it can produce at relatively low cost. This principle is unconventional because, this proposition brings out the idea that even though one country is absolutely more productive or efficient in all the items compared to another country, it is better off by exporting items in which it has relatively higher productivity advantage and importing products in which it has relatively lower advantage.

This makes trade between a developed and developing country possible.

The principle was first explained by David Ricardo.

Illustration: USA is a unit of food costs 1 hour of labor and a unit of clothing costs 2 hours of labor.
In Europe, one unit of food costs 3 hours of labor and a unit of clothing costs 4 hours of labor.
This means that  1 unit of food is equal to 0.5 units of cloth in USA.
1 unit of food is equal to 3/4 units of cloth in Europe.
Cloth is exported to USA and food is bought with it till relative prices are equal. Let us say relative price become equal at 2/3. It means in USA 1 unit of food buy 2/3 units of cloth. In Europe also one unit of food is equal to 2/3 times of cloth.

In the situation of after trade, the USA persons have to spend only 2 and half hours to get 1 unit of food and one unit of cloth. Earlier, before trade he has to spend 1 hour for food and two hours for cloth. So he is better of.

Similarly the European needs to spend only 6 and 2/3 hours for 1 unit of food and 1 unit of cloth instead of 7 hours. So he is also better of.

Absolute and Comparative Advantage



Paul Samuelson and William D. Nordhaus, Economics, 13th Edition, McGraw-Hill, 1989

Updated 8 July 2017,  23.12.2012, 11 December 2011

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