Question

What is an important insight of international trade theory regarding when two countries engage in voluntary trade? Explain your answer based on the three trade theories seen in class and give a real-world example for each of the three theories.

Answer 1

The two nations trade because this helps them to acquire resources that they don't have, and sell the abundant and cheaply produced goods to finally increase income and consumption. trade enables the nations to specialize in export of certain goods and payback for their imports. So, associated with the idea are three classical theories.

First is the mercantilism, whose idea is that a country’s wealth is dependent on the net exports. According to this theory, a country should export more and discourage imports by using taxes and subsidies. In the days of earlier times, the gold was primarily used as a mean of trading between the countries. So, the larger the gold, the wealthier a nation was. It is in accordance with this wealth idea that the exports were promoted more than the imports. The wealth was accumulated by trading so as to build large armies and national institutions in world history from 1500 to late1800s. In today's time also, China, Japan, Singapore still prioritize the exports over the imports.

Second is absolute advantage theory focuses on the ability of a country t0 produce a good more efficiently than other countries. This helps the countries in specializing in producing that good and trade it with the other country. One such example of absolute advantage is Indian call center where the cost of buying this service is very cheap as against locating the same in the USA. This makes the US trade with India to buy these services (from a specialized country).

The third theory is the comparative advantage theory which says that even if a country is efficient in producing both the goods than the other, there is still a chance to trade wherein a country can have a comparative advantage in producing a good because of lower relativeop[portunity cost. One great example of this theory is the two nations USA and China. Both these nations are specialized in producing planes and electronics. However, as per the comparative advantage, US exports planes while import electronics and vice versa for China.