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There are several reasons due to which countries do trade with other countries. They are as follows:-
- Generates revenue: – The main reason for which the countries do trade is that it generates revenue through duties being imposed on goods which are imported in the country.
- Gives Comparative advantage: – Trade amongst the countries gives comparative advantage to them i.e. it encourages the nations to manufacture goods and services which they can produce more effectively and efficiently.
- Lowest opportunity cost: – It also encourages countries to produce those goods which have lowest opportunity cost and at the same time encourages them to import goods which have more opportunity cost from other countries.
- Economies of Scale: – When countries range narrows in terms of producing goods and services then efficiency and effectiveness increases even more and country can produce those goods in high volumes with less cost which eventually helps the countries in achieving economies of scale.
- Breaks down monopolies: – When country comes into trade with other countries then new entrants enter into the countries domestic market, which gives increases the competition for the domestic market. The humans have a tendency that they do not try to innovate new methods until the time they do not face any competition. Such competition has two benefits firstly the quality and innovative goods are produced by the business firms. Secondly it finishes i.e. breaks down the domestic monopolies and eventually it helps the country’s consumers.
- Increase in Employment: – Trading amongst the countries lead to more production of goods and services. More the production more employment needs to be done to cope up or meet out the deadlines of the export order.
All these factors encourage a country to do trade and achieve better economy.
Theory of Comparative Advantage: – Theory of comparative advantage lays down that it helps the country in producing only those goods which they can produce with lowest opportunity cost as compare to the other countries and at the same time encourages them to import those goods whose opportunity cost would have cost them high if they would have produced them in their own country.
It was David Ricardo in nineteenth century that with the help of a numerical example showed the benefits of the comparative advantage. Before this countries early logic related to free trade could be advantageous was based on absolute advantage. Ricardo in his example showed that suppose there are two countries England and Portugal. If England is good in producing cloth with low cost whereas the same good production cost high to Portugal and on the other hand Portugal is good in producing wine whereas the wine production cost high to England. So it will be relatively beneficial for both the countries to produce only those goods which cost them less in high volumes and to buy the other good from other country rather than making it on a high cost this way it increases the production of a particular good at global level and encourages the country to buy those goods or commodities from other countries at cheaper price rather than producing them at high cost. This way Ricardo showed the advantageous side of the comparative advantage to the countries.
Assumptions behind Comparative advantage: –
- There are two countries. Let the two countries be X and Y.
- They produce the same two goods or commodities. Let the two goods be A and B. The nature of quality of these goods in both countries is similar.
- The main factor of production is labour, which should be homogeneous and unchanged.
- The resources should not be mobile between countries.
- The production of a good should be subject to equal return.
- There should be no transport cost between two countries.
- Productivity for same good will vary between two countries.
Factor endowment: – It is a major factor which impacts the country’s economy by payingmore attention specialized goods which have low opportunity cost as compare to other goods. When we talk of lower opportunity cost of particular good in a country then it means low opportunity cost in terms of the other nations of same good. This is what we call comparative advantage of a country over other nations in terms of production of some specialized product. Comparative advantage can arise due to abundance of raw material, due to high productivity, cheap or highly skilled labor, or may be land or capital and last but not the least in some cases countries achieve economies of scale. The most affecting and simple form of example with respect to the land could be fertile soil which gives high input of agriculture products which country like India can export and make high profits on it.
Labor productivity: – This is term given to one of the measure which is often used in economics to know the economic growth of the country. As the name suggest it is a measure of amount of goods produced by a labor in one hour. Growth in labor productivity depends on investment and saving in physical capital, new technology, and human capital.
How it is measured: – The real GDP (gross domestic product) of an economy divided by the aggregate hours of labor in the country gives per labor of hour.
Importance of measuring labor productivity: – It is very much important to measure and know how much the growth in the country’s labor productivity is, as it shows the living standard in respect of the consumption. As the only reason in the growth of labor productivity could be the increase in number of hours they worked in a year and that is only due to the high production of goods. So more the labor productivity more will be the production of the goods and so it will boost the country’s caliber to export the extra produced goods to other nations and gain profit.
It is a method or a measure a country uses to protect its domestic market from unfair competition which from foreign industries. No doubt country uses it for the welfare of its own and it works out to be a good for short run. But eventually with the span of time it makes the domestic market more lethargic and less innovative. Humans have a tendency they do not work hard until they get some competition. So such kinds of competitions are good up to an extent as it favors the citizens of country in terms of production of qualitative and innovative goods.
Methods generally used as protectionism:-
Firstly, by increasing the tariffs and tax on the imported products into the country which eventually makes the imported product less competitive as compare to the domestic one because they cannot match the price of the local products due to high paid tariff and taxes on the goods. Secondly, by subsidizing the local producers. That lowers the cost of their product. This method works two ways i.e. for domestic industry and even for the export sector as they have to pay less shipment cost. Thirdly, the countries also impose quotas on the imported goods which bound the foreign countries to export certain product only up to some extent. This works even well than the other two, so no matter how low they sell they can harm the local industries only up to a certain extent of time. And fourthly, also sometimes country deliberately lower their currency’s so that they can make their export cheaper and more competitive in global market.
So, protectionism plays a vital role as a protection tool in country’s international trade to save its domestic industry from foreign industries.
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Economics Online. (n.d.). Why do countries trade. Retrieved February 8th, 2017, from Economics Online: www.economicsonline.co.uk/global-economices/why_do_countries_trade.html
Investopedia. (2015, april 16). How to factors endowment impact a country’s comperative advantage. Retrieved feb 14, 2017, from www.investopedia.com: www.investopedia.com/ask/answers/041615/how-do-factor-endowments-impact-countrys-comparative-advantage.asp
Investopedia. (n.d.). Labor Productivity. Retrieved feb 14, 2017, from www.investopedia.com: www.investopedia.com/terms/l/labor-productivity.asp
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