Question

Why do countries trade with each other? What would happen if countries curtailed or did not trade with each other? Select a theory discussed in chapter 2, explaining why it is beneficial for a country to engage in international trade.

Answer 1

Trade is generally beneficial for the economies of the country and help the countries utilize their scarce resource better. For example, there are only two countries in the world India and USA. The USA is a capital abundant country and can produce a limited amount of capital good and labor good. On the other hand, India is a labor abundant country and can produce a limited amount of both capital and labor goods. Both the countries consume both the goods.

Now, in case of an autarky i.e. no trade between both the countries they both are forced to produce both the goods capital and labor-intensive good. This is preventing them to attain economies of scale, maximum utilization of their resources etc. Now with trade, one country can achieve maximum specialization in producing one good which they can produce at a lower cost i.e. Capital good for USA and Labor good for India. Both the countries will benefit from the cheaper availability of goods and end up consuming more than before. They will not have achieved all this if they have not traded with each other.

Here, in the example, the USA has a comparative advantage in the production of Capital goods and India has a comparative advantage in the production of labor goods. According to the law of comparative advantage if they both trade the US can specialize and produce only capital goods at a lower price and India can specialize in the production of labor goods. By trading, both will get cheaper goods hence end up consuming more of the goods than before it will also reduce wastage of scarce resources and help achieve economies of scale.