I. Features of International Trade
- Natural resources are unevenly distributed over the earth. Different nations have different
endowments on resources. The endowments would affect their production capacity and types
of goods & services produced.
- Production depends on specialization. Specialization in turn encourages trade. It lowers the
possibility of self-sufficiency and increases the level of mutual dependence among nations.
- International trade expands the size of the market. Once the market size is enlarged, there is
more chance to specialize.
II. Difficulties of International Trade
- Many people argue that the developing nations face with an undesirable terms of trade ( the ratio of export price to import price ). The developed nations are simply capturing gains from them.
- Trade barriers hinders the development of international trade.
III. Economic Principle of International Trade
International trade is based on an important theory in economics. It is called the theory of
Absolute Advantage. A nation is said to have an absolute advantage in the production of a good if it can produce a greater quantity of the good than that of another nation, with the same amount of resources used or at the same cost.
- Comparative Advantage. When a nation has a lower opportunity cost in producing a good, it is said to have a comparative advantage in the production of that good.
- The theory states that if a nation specializes in the production of a good with a comparative advantage, i.e. a lower opportunity cost; more output can be produced provided that other nations do accordingly. Nations will gain if they exchange according to this principle, provided that the exchange ratio lies within their domestic cost ( with low or even zero transportation cost ).
IV. Trade Protection
Forms of Trade Protection / Barriers
- Tariffs. A tariff is an import tax levied by the importing nation. It will lead to revenue to the government.
- Import Quotas. Quota refers to a maximum amount of quantity set on imports within a time period. Both tariffs and quotas have similar effects on the prices & volume of imports. The effect of a tariff on imports depends on the price elasticity of demand for imports. The effect of a quota is more certain.
- Embargo. It is a complete prohibition of trade in general. A partial embargo refers to a prohibition of trade on certain selective commodities only.
Reasons for Trade Protection
- Infant Industry Argument. When a domestic industry just starts to grow, it is not strong enough to face foreign competition. It should be protected by the government to allow it to grow. The developing nations always use barriers during their early stage of industrialisation.
- Local Workers & Employment. A restriction of imports would encourage the local industries to survive. As a result, local firms would provide more employment opportunities to workers.