International Trade Theory 12.

The benefits of trade

International trade involves the exchange of goods and services across international boundaries. Countries sell goods and services produced domestically to buyers abroad; these are exports. They also buy goods/services from other countries for domestic use; these are imports. In recent decades, the value of exports and imports as a share of GDP has been increasing in most countries around the world. As a result, international trade has a major role in economic activities and economic performace of countries everywhere. Countries trade with each other because they derive a number of important benefits from trade. Benefits Trade allows domestic production and consumption to increase as a result of specialisation Specialisation occurs when an individual, a firm or a country concentrates production on one or a few goods and services. Specialisation by a country in the production of a range of goods or services it can produce efficiently. A country that does not trade must produce all the goods and services consumed domestically by itself6, and therefore cannot specialise. If one the other hand it uses its resources to specialise in the production of a particular good/service that it can produce more efficiently, it can produce more of these and exchange some of them for other goods produced more efficiently in other countries. Therefore it will be in a position to produce a greater volume of output because it will not waste its scarce resources producing goods and services that it can only produce at a relatively high cost. Can also increase consumption because by exporting a part of its larger domestic output in exchange for other output produced more cheaply elsewhere, it can acquire a larger overall quantity of goods and services for consumption. The possibility of increased production/consumption through specialisation occurs because countries can take advantage of differences in factor endowment. Factor endowments are the factors of production that a country possesses. Each country has widely differing amounts of land, labour, capital and entrepeurnership. Countries are very different from each other with respect to the quantities of resources they possess, the quality of their resources, their geographical locations and the types and levels of technology they use in production. Different countries are more efficient in the production of certain goods/services than others.

According to the theory of comparative advantage, of countries specialise in the production of goods/services in which they are most efficient because of their own particular factor endowments, they will cut down on the waste of scarce resources and can produce a larger quantity of goods and services. They can then export some of these in exchange for other goods and services produced at a lower cost. If countries specialise and trade with each other, world output will increase and all the countries will share the benefits- they will all produce and consume a larger quantity of goods and services.

Countries can achieve economies of scale in production This involves the ability of a firm to decrease average costs of production by increasing the size of its operations (the firm size) and the quantity of output it produces. If a firm succeeds in lowering its average costs of production it becomes more efficient in production and it can sell its output at a lower price. In the absence of trade, the amount of output that any firm can produce is limited by the size of the domestic market. If the domestic market is small, then the firm will not be able to grow and take advantage of economies of scale. On the other hand, the possibility of trade and exports to other countries involves an expansion in the size of the market, allowing firms to produce more output, achieve economies of scale and enjoy the benefits of lower costs, which include lower prices and therefore greater export competitiveness.

Trade can increase the variety and quantity of goods and services available to consumers The goods and services that each country can produce differ widely with respect to their variety and quality. By trading with each other, countries can acquire a larger variety of goods and services and may be able to purchase higher quality goods/services than the ones they are able to produce themselves.

Trade allows countries to acquire needed resources Countries may need for their domestic production a number of natural resources or capital goods that are unavailable domestically. E.g. oil is a resource that almost all countries depend on, yet are forced to rely on imported oil because they do not produce it themselves. Trade allows countries to import inputs they need for domestic production.

Trade results in increased competition leading to greater efficiency in production

When countries trade with each other, domestic firms become exposed to competition from products produced by firms in other countries. They are therefore forced to become more efficient, and must try to produce at the lowest possible cost. If they do not become more efficient, they will have to sell their output at higher prices in order to cover their higher costs; consumers will prefer the lower-priced imported products and the firms with the higher costs may eventually be forced to go out of business.

Trade makes possible the flow of new ideas and technology As goods and services flow from one country to another they enable new ideas and new technologies and skills to be transferred.

Trade makes other countries interdependent, reducing the possibilities of hostilities and violence. Strong international trade links between countries can form the basis for economic relationships that prelude the possibility of war. Eg one of the reasons for the foundation of the European Economic Community was to eliminate the possibility of future wars between France and Germany. The strong economic interdependence makes the possibility of war between them inconceivable today.

Increased exports and greater efficiency in production lead to more economic growth Increased specialisation, economies of scale, greater efficiencies in production, acquisition of needed resources, increased competition, technological advances and expanding markets, all of which are made possible by international trade, contribute to increases in domestic output, and therefore to greater economic growth. More exports means that a country has more possibilities to import resources that are important to increasing its domestic production of goods and services which also contributes to economic growth. International trade= engine for growth.

Increased exports make it possible for countries to achieve greater economic development A country that achieves more rapid growth through increased exports has far greater possibilities to pursue economic development objectives and to achieve both economic and human development.