Imports and exports are accounted for in the current account section in a country's balance of payments. Global trade allows wealthy countries to use their resources—for example, labor, technology, or capital —more efficiently. Different countries are endowed with different assets and natural resources: land, labor, capital, and technology, etc.
This allows some countries to produce the same good more efficiently—in other words, more quickly and at lower cost. Therefore, they may sell it more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain it by trading with another country that can.
This is known as specialization in international trade. For example, England and Portugal have historically both benefited by specializing and trading according to their comparative advantages. Portugal has plentiful vineyards and can make wine at a low cost, while England is able to more cheaply manufacture cloth given its pastures are full of sheep.
Each country would eventually recognize these facts and stop attempting to make the product that was more costly to generate domestically in favor of engaging in trade.
Indeed, over time, 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 in order to acquire them. These two countries realized that they could produce more by focusing on those products for which they have a comparative advantage. In such a case, the Portuguese would begin to produce only wine, and the English only cotton.
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 both products at lower costs.
We can see then that for both countries, the opportunity cost of producing both products is greater than the cost of specializing. Comparative advantage can contrast with absolute advantage.
Absolute advantage leads to unambiguous gains from specialization and trade only in cases wherein each producer has an absolute advantage in producing some good. If a producer lacked any absolute advantage, then they would never export anything.
But we do see that countries without any clear absolute advantage do gain from trade because they have a comparative advantage. According to the international trade theory, even if a country has an absolute advantage over another, it can still benefit from specialization. The theory of comparative advantage has been attributed to the English political economist David Ricardo. Comparative advantage is discussed in Ricardo's book On the Principles of Political Economy and Taxation , published in , although it has been suggested that Ricardo's mentor, James Mill, likely originated the analysis and slipped it into Ricardo's book on the sly.
Comparative advantage, as we have shown above, 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.
Chinese workers produce simple consumer goods at a much lower opportunity cost. The comparative advantage for the U. American workers produce sophisticated goods or investment opportunities at lower opportunity costs. Specializing and trading along these lines benefit each country.
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. Countries trade with each other when, on their own, they do not have the resources, or capacity to satisfy their own needs and wants.
By developing and exploiting their domestic scarce resources , countries can produce a surplus, and trade this for the resources they need. Clear evidence of trading over long distances dates back at least 9, years, though long distance trade probably goes back much further to the domestication of pack animals and the invention of ships.
Today, international trade is at the heart of the global economy and is responsible for much of the development and prosperity of the modern industrialised world. Goods and services are likely to be imported from abroad for several reasons.
Imports may be cheaper, or of better quality. They may also be more easily available or simply more appealing than locally produced goods. In many instances, no local alternatives exist, and importing is essential. The production of goods and services in countries that need to trade is based on two fundamental principles, first analysed by Adam Smith in the late 18 th Century in The Wealth of Nations, , these being the division of labour and specialisation.
If you're not sure whether or not you're ready to partake in the advantages of international trade, you might want to check out the resources available for you at The International Trade Administration ITA.
In addition to export education material, the site gives an export readiness assessment. Read more articles on business expansion. Skip to content. Business Cards. Payment Solutions. International Payments. Business Class. What Are the Advantages of International Trade?
Summary The internet and technology have made it much easier for businesses of all sizes to profit from the many advantages of international trade. Increased revenues One of the top advantages of international trade is that you may be able to increase your number of potential clients.
Decreased competition Your product and services may have to compete in a crowded market in the U. Table of Contents. Next Section. Recognize that separate models of trade incorporate different motivations for trade. Reason for Trade 1: Differences in Technology Advantageous trade can occur between countries if the countries differ in their technological abilities to produce goods and services.
Reason for Trade 2: Differences in Resource Endowments Advantageous trade can occur between countries if the countries differ in their endowments of resources.
Reason for Trade 3: Differences in Demand Advantageous trade can occur between countries if demands or preferences differ between countries. Reason for Trade 4: Existence of Economies of Scale in Production The existence of economies of scale in production is sufficient to generate advantageous trade between two countries.
Reason for Trade 5: Existence of Government Policies Government tax and subsidy programs alter the prices charged for goods and services. Summary There are very few models of trade that include all five reasons for trade simultaneously.
Key Takeaways The five main reasons international trade takes place are differences in technology, differences in resource endowments, differences in demand, the presence of economies of scale, and the presence of government policies.
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