This article at explaining why countries engage in international trade. Now days it is not uncommon to find that the main objective of a trade policy of almost all countries is to promote international trade. Countries have gone ahead to engage in trade negotiations all in the interest of enabling international trade. But then, why do countries engage in international trade? Why are there global attempts to liberalize international trade rather than promote autarky-a situation of no international trade? Does engaging in international trade contribute to income distribution, factor employment and poverty reduction? In short, must a country engage in international trade in order to develop? This article delves into theories of trade so as to understand why countries engage in international trade. Economist believes that if countries engage in international trade, they can mostly benefit under a free international trade environment. To get a clear perspective to this claim, I will glance though five major main theories on international trade-the Ricardian Comparative advantage Model on gains from specialization and opportunity cost theory, Heckscher-Ohlin model who believes that factor proficiency differences are the reasons why countries engage in international trade because of the gains from specialization and income distribution effects, the new international trade theory which examines the economies of scale and the Heterogeneous firms theory which explains why countries engage in international trade basing on a firm level perspective.
Gains from Specialization by David Ricardo
According to David Ricardo (1817), countries engage in international trade because they stand to gain if they specialize in the production of products with low opportunity cost. To Ricardo countries should understand their factor endowments then direct production to the best alternative in utilizing the available resources. A country undertaking such specialization would then enage in international trade with others countries to get those products which are of second best alternative in utilization of resources.
Ricardo emphasizes his point using the opportunity cost theory. Noting that resources are scarce, a country has to give up production of one product in order to produce the other. To know which one to give up, a country has to determine where it would have higher output if the same resource available was utilized in the production of either product. A country would specialize in production of that product whose utilization of the available resource produces the most output. In opportunity cost terms, a country should specialize in production of that product whose cost for failure to produce it is higher than that of the second alternative. To Ricardo countries are endowed differently and so they have different opportunity costs. The difference in opportunity cost is what would enable countries to enage in international trade with each other so as to get the disdvantaged products. Ricardo sums up the above with the use of what he called the absolute and comparative advantages. To him even if a country would produce more of the two products than the other country (the absolute advantage), it should specialize in producing that product in which it has an advantage in utilization of the available resources (comparative advantage). Let us now examine this theory using the following example. The theory assumes;
1. There are two countries to enage in international trade-We will use Rainlands and United Parkland 2. There are two products produced- i.e. Coffee and Computers 3. One factor of production exists- i.e. Labour
4. Factor productivity is constant
5. Perfect competition exists in the market
6. Homogeneous of factors-They have fixed and same abilities and productivity levels 7. Factors are perfectly mobile within country and between sectors –Can be shifted from...