Question

why country trade

Answer 1

Answer :

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, 1776), these being the division of labour and specialisation.

The advantages of trade : International trade brings a number of valuable benefits to a country, including:

1. The exploitation of a country’s comparative advantage, which means that trade encourages a country to specialise in producing only those goods and services which it can produce more effectively and efficiently, and at the lowest opportunity cost.
2. Producing a narrow range of goods and services for the domestic and export market means that a country can produce in at higher volumes, which provides further cost benefits in terms of economies of scale.
3. Trade increases competition and lowers world prices, which provides benefits to consumers by raising the purchasing power of their own income, and leads a rise in consumer surplus.
4. Trade also breaks down domestic monopolies, which face competition from more efficient foreign firms.
5. The quality of goods and services is likely to increases as competition encourages innovation, design and the application of new technologies. Trade will also encourage the transfer of technology between countries.
6. Trade is also likely to increase employment, given that employment is closely related to production. Trade means that more will be employed in the export sector and, through the multiplier process, more jobs will be created across the whole economy.

Division of labour : In its strictest sense, a division of labour means breaking down production into small, interconnected tasks, and then allocating these tasks to different workers based on their suitability to undertake the task efficiently. When applied internationally, a division of labour means that countries produce just a small range of goods or services, and may contribute only a small part to finished products sold in global markets. For example, a bar of chocolate is likely to contain many ingredients from numerous countries, with each country contributing, perhaps, just one ingredient to the final product.

Specialisation

Specialisation is the second fundamental principle associated with trade, and results from the division of labour. Given that each worker, or each producer, is given a specialist role, they are likely to become efficient contributors to the overall process of production, and to the finished product. Hence, specialisation can generate further benefits in terms of efficiency and productivity. Specialisation can be applied to individuals, firms, machinery and technology, and to whole countries. International specialisation is increased when countries use their scarce resources to produce just a small range of products in high volume. Mass production allows a surplus of goods to be produced, which can then be exported. This means that goods and resources must be imported from other countries that have also specialised, and produced surpluses of their own.

Differences in Technology : Advantageous trade can occur between countries if the countries differ in their technological abilities to produce goods and services. Technology refers to the techniques used to turn resources (labor, capital, land) into outputs (goods and services). The basis for trade in the Ricardian model of comparative advantage is differences in technology.

Differences in Resource Endowments : Advantageous trade can occur between countries if the countries differ in their endowments of resources. Resource endowments refer to the skills and abilities of a country’s workforce, the natural resources available within its borders (minerals, farmland, etc.), and the sophistication of its capital stock (machinery, infrastructure, communications systems). The basis for trade in both the pure exchange model and the Heckscher-Ohlin model is differences in resource endowments.

Differences in Demand : Advantageous trade can occur between countries if demands or preferences differ between countries. Individuals in different countries may have different preferences or demands for various products. For example, the Chinese are likely to demand more rice than Americans, even if consumers face the same price. Canadians may demand more beer, the Dutch more wooden shoes, and the Japanese more fish than Americans would, even if they all faced the same prices. There is no formal trade model with demand differences, although the monopolistic competition model does include a demand for variety that can be based on differences in tastes between consumers.

Existence of Economies of Scale in Production : The existence of economies of scale in production is sufficient to generate advantageous trade between two countries. Economies of scale refer to a production process in which production costs fall as the scale of production rises. This feature of production is also known as “increasing returns to scale.” Two models of trade incorporating economies of scale.

Existence of Government Policies : Government tax and subsidy programs alter the prices charged for goods and services. These changes can be sufficient to generate advantages in production of certain products. In these circumstances, advantageous trade may arise solely due to differences in government policies across countries. There are several ways in which domestic tax or subsidy policies can induce international trade.