Scribd Logo
Upload

Welcome to Scribd!

  • 81 views

    How International Trade Works

    Uploaded by

    fe
    International trade allows countries to specialize in producing goods that they have a comparative advantage in, which increases global economic efficiency. When countries specialize and trade based on their comparative costs of production, both countries can consume more goods than if each produced everything itself. For example, one country may specialize in producing cotton sweaters while another focuses on wine based on their relative opportunity costs, then they can trade and both consume more of both goods. While some argue that free trade benefits are not always evenly distributed, most economists agree that specialization and trade according to comparative advantage maximizes global production and consumption.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd

    How International Trade Works

    Uploaded by

    fe
    81 views4 pages
    International trade allows countries to specialize in producing goods that they have a comparative advantage in, which increases global economic efficiency. When countries specialize and trade based on their comparative costs of production, both countries can consume more goods than if each produced everything itself. For example, one country may specialize in producing cotton sweaters while another focuses on wine based on their relative opportunity costs, then they can trade and both consume more of both goods. While some argue that free trade benefits are not always evenly distributed, most economists agree that specialization and trade according to comparative advantage maximizes global production and consumption.

    Copyright

    © © All Rights Reserved

    Available Formats

    DOCX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    International trade allows countries to specialize in producing goods that they have a comparative advantage in, which increases global economic efficiency. When countries specialize and trade based on their comparative costs of production, both countries can consume more goods than if each produced everything itself. For example, one country may specialize in producing cotton sweaters while another focuses on wine based on their relative opportunity costs, then they can trade and both consume more of both goods. While some argue that free trade benefits are not always evenly distributed, most economists agree that specialization and trade according to comparative advantage maximizes global production and consumption.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    81 views4 pages

    How International Trade Works

    Uploaded by

    fe
    International trade allows countries to specialize in producing goods that they have a comparative advantage in, which increases global economic efficiency. When countries specialize and trade based on their comparative costs of production, both countries can consume more goods than if each produced everything itself. For example, one country may specialize in producing cotton sweaters while another focuses on wine based on their relative opportunity costs, then they can trade and both consume more of both goods. While some argue that free trade benefits are not always evenly distributed, most economists agree that specialization and trade according to comparative advantage maximizes global production and consumption.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 4

    How International Trade Works

    International trade gives rise to a world economy, in which supply and


    demand, and therefore prices, both affect and are affected by global events.
    Political change in Asia, for example, could result in an increase in the cost of
    labor, thereby increasing the manufacturing costs for an American sneaker
    company based in Malaysia, which would then result in an increase in the
    price charged at your local mall. A decrease in the cost of labor, on the other
    hand, would likely result in you having to pay less for your new shoes.

    A product that is sold to the global market is called an export, and a product
    that is bought from the global market is an import. Imports and exports are
    accounted for in a country's current account in the balance of payments.

    Comparative Advantage: Increased Efficiency of Trading


    Globally
    Global trade allows wealthy countries to use their resources—whether labor,
    technology or capital—more efficiently. Because countries are endowed with
    different assets and natural resources (land, labor, capital, and technology),
    some countries may produce the same good more efficiently and therefore
    sell it more cheaply than other countries. If a country cannot efficiently
    produce an item, it can obtain the it by trading with another country that can.
    This is known as specialization in international trade.

    Let's take a simple example. Country A and Country B both produce cotton
    sweaters and wine. Country A produces ten sweaters and six bottles of wine a
    year while Country B produces six sweaters and ten bottles of wine a year.
    Both can produce a total of 16 units. Country A, however, takes three hours to
    produce the ten sweaters and two hours to produce the six bottles of wine
    (total of five hours). Country B, on the other hand, takes one hour to produce
    ten sweaters and three hours to produce six bottles of wine (a total of four
    hours).

    But these two countries realize that they could produce more by focusing on
    those products with which they have a comparative advantage. Country A
    then begins to produce only wine, and Country B produces only cotton
    sweaters. Each country can now create a specialized output of 20 units per
    year and trade equal proportions of both products. As such, each country now
    has access to 20 units of both products.

    We can see then that for both countries, the opportunity cost of producing
    both products is greater than the cost of specializing. More specifically, for
    each country, the opportunity cost of producing 16 units of both sweaters and
    wine is 20 units of both products (after trading). Specialization reduces their
    opportunity cost and therefore maximizes their efficiency in acquiring the
    goods they need. With the greater supply, the price of each product would
    decrease, thus giving an advantage to the end consumer as well.

    Note that, in the example above, Country B could produce both wine and
    cotton more efficiently than Country A (less time). This is called an absolute
    advantage, and Country B may have it because of a higher level of
    technology.

     
    According to the international trade theory, even if a country has an absolute
    advantage over another, it can still benefit from specialization.
    Origins of Comparative Advantage
    The law of comparative advantage is popularly attributed to English political
    economist David Ricardo. It's discussed in his book “On the Principles of
    Political Economy and Taxation” published in 1817, although it has been
    suggested that Ricardo's mentor, James Mill, likely originated the analysis.

    David Ricardo famously showed how England and Portugal both benefit by
    specializing and trading according to their comparative advantages. In this
    case, Portugal was able to make wine at a low cost, while England was able
    to cheaply manufacture cloth. Ricardo predicted that each country would
    eventually recognize these facts and stop attempting to make the product that
    was more costly to generate.

    Indeed, as time went on, England stopped producing wine, and Portugal
    stopped manufacturing cloth. Both countries saw that it was to their advantage
    to stop their efforts at producing these items at home and, instead, to trade
    with each other.

    Some scholars have recently argued that Ricardo did not actually come up
    with comparative advantage. Instead, the idea may have been inserted by his
    editor, the political economist and moral philosopher James Mill.
    A contemporary example is China’s comparative advantage with the United
    States in the form of cheap labor. Chinese workers produce simple consumer
    goods at a much lower opportunity cost. The United States’ comparative
    advantage is in specialized, capital-intensive labor. American workers produce
    sophisticated goods or investment opportunities at lower opportunity costs.
    Specializing and trading along these lines benefits each.

    The theory of comparative advantage helps to explain why protectionism has


    been traditionally unsuccessful. If a country removes itself from an
    international trade agreement, or if a government imposes tariffs, it may
    produce an immediate local benefit in the form of new jobs and industry.
    However, this is often not a long-term solution to a trade problem. Eventually,
    that country will grow to be at a disadvantage relative to its neighbors:
    countries that were already better able to produce these items at a lower
    opportunity cost.

    Criticisms of Comparative Advantage


    Why doesn't the world have open trading between countries? When there is
    free trade, why do some countries remain poor at the expense of others?
    There are many reasons, but the most influential is something that economists
    call rent-seeking. Rent-seeking occurs when one group organizes
    and lobbies the government to protect its interests.

    Say, for example, the producers of American shoes understand and agree
    with the free-trade argument—but they also know that their narrow interests
    would be negatively impacted by cheaper foreign shoes. Even if laborers
    would be most productive by switching from making shoes to making
    computers, nobody in the shoe industry wants to lose his or her job or
    see profits decrease in the short run.

    This desire could lead the shoemakers to lobby for special tax breaks for their
    products and/or extra duties (or even outright bans) on foreign footwear.
    Appeals to save American jobs and preserve a time-honored American craft
    abound—even though, in the long run, American laborers would be made
    relatively less productive and American consumers relatively poorer by such
    protectionist tactics.

    Other Possible Benefits of Trading Globally 


    International trade not only results in increased efficiency but also allows
    countries to participate in a global economy, encouraging the opportunity
    for foreign direct investment (FDI), which is the amount of money that
    individuals invest into foreign companies and assets. In theory, economies
    can therefore grow more efficiently and can more easily become competitive
    economic participants.

    For the receiving government, FDI is a means by which foreign currency and


    expertise can enter the country. It raises employment levels, and theoretically,
    leads to a growth in gross domestic product. For the investor, FDI offers
    company expansion and growth, which means higher revenues.

    Free Trade Vs. Protectionism


    As with all theories, there are opposing views. International trade has two
    contrasting views regarding the level of control placed on trade: free trade and
    protectionism. Free trade is the simpler of the two theories: a laissez-faire
    approach, with no restrictions on trade. The main idea is that supply and
    demand factors, operating on a global scale, will ensure that production
    happens efficiently. Therefore, nothing needs to be done to protect or promote
    trade and growth, because market forces will do so automatically.
    In contrast, protectionism holds that regulation of international trade is
    important to ensure that markets function properly. Advocates of this theory
    believe that market inefficiencies may hamper the benefits of international
    trade, and they aim to guide the market accordingly. Protectionism exists in
    many different forms, but the most common are tariffs, subsidies, and quotas.
    These strategies attempt to correct any inefficiency in the international market.

    As it opens up the opportunity for specialization, and therefore more efficient


    use of resources, international trade has the potential to maximize a country's
    capacity to produce and acquire goods. Opponents of global free trade have
    argued, however, that international trade still allows for inefficiencies that
    leave developing nations compromised. What is certain is that the global
    economy is in a state of continual change, and, as it develops, so too must its
    participants.

    You might also like