Trade

What Is Trade?

Trade is a basic economic concept involving the buying and selling of goods and services, with compensation paid by a buyer to a seller, or the exchange of goods or services between parties. Trade can take place within an economy between producers and consumers. International trade allows countries to expand markets for both goods and services that otherwise may not have been available. It is the reason why an American consumer can pick between a Japanese, German, or American car. As a result of international trade, the market contains greater competition and therefore, more competitive prices, which brings a cheaper product home to the consumer.

KEY TAKEAWAYS

• Trade broadly refers to the exchange of goods and services, most often in return for money.
• Trade may take place within a country, or between trading nations. For international trade, the theory of comparative advantage predicts that trade is beneficial to all parties, although critics argue that in reality, it leads to stratification among countries.
• Economists advocate for free trade between nations, but protectionism such as tariffs may present themselves due to political motives, for instance with "trade wars."                                                                                                                                                                                                                                                                                                                                                                                          

  How Trade Works

  Trade broadly refers to transactions ranging in complexity from the exchange of baseball cards between collectors to multinational policies setting protocols for imports and exports between countries. Regardless of the complexity of the transaction, trading is facilitated through three primary types of exchanges.                                                                                                                                           Trading globally between nations allows consumers and countries to be exposed to goods and services not available in their own countries. Almost every kind of product can be found on the international market: food, clothes, spare parts, oil, jewelry, wine, stocks, currencies, and water. Services are also traded: tourism, banking, consulting, and transportation. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country's current account in the balance of payments.

  
  

  International trade not only results in increased efficiency but also allows countries to participate in a global economy, encouraging the opportunity of foreign direct investment (FDI), which is the amount of money that individuals invest into foreign companies and other assets. In theory, economies can, therefore, grow more efficiently and can more easily become competitive economic participants. For the receiving government, FDI is a means by which foreign currency and expertise can enter the country. These raise employment levels, and, theoretically, lead to a growth in the gross domestic product. For the investor, FDI offers company expansion and trade deficit is a situation where a country spends more on aggregate imports from abroad than it earns from its aggregate exports. A trade deficit represents an outflow of domestic currency to foreign markets. This may also be referred to as a negative balance of trade (BOT)                                                                                                                                                                           

  Comparative Advantage: Increased Efficiency of Trading Globally

  Global trade, in theory, allows wealthy countries to use their resources—whether labor, technology, or capital—more efficiently. Because countries are endowed with different assets and natural resources (land, labor, capital, and technology), some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain the item by trading with another country that can. This is known as specialization in international trade.

  Let's take a simple example. Country A and Country B both produce cotton sweaters and wine. Country A produces ten sweaters and ten bottles of wine a year while Country B also produces ten sweaters and ten bottles of wine a year. Both can produce a total of 20 units without trading. Country A, however, takes two hours to produce the ten sweaters and one hour to produce the ten bottles of wine (total of three hours). Country B, on the other hand, takes one hour to produce ten sweaters and one hour to produce ten bottles of wine (a total of two hours).

  But these two countries realize by examining the situation that they could produce more, in total, with the same amount of resources (hours) by focusing on those products with which they have a comparative advantage. Country A then begins to produce only wine, and Country B produces only cotton sweaters.

  Country A, by specializing in wine, can produce 30 bottles of wine with its 3 hours of resources at the same rate of production per hour of resource used (10 bottles per hour) before specialization. Country B, by specializing in sweaters, can produce 20 sweaters with its 2 hours of resources at the same rate of production per hour (10 sweaters per hour) before specialization.

  The total output of both countries is now the same as before in terms of sweaters—20—but they are making 10 bottles of wine more than if they did not specialize. This is the gain from specialization that can result from trading. Country A can send 15 bottles of wine to Country B for 10 sweaters and then each country is better off—10 sweaters and 15 bottles of wine each compared with 10 sweaters and 10 bottles of wine before trading.

  Note that, in the example above, Country B could produce wine more efficiently than Country A (less time) and sweaters as efficiently. This is called an absolute advantage in wine production and at an equal cost in terms of sweaters. Country B may have these advantages because of a higher level of technology. However, as the example shows Country B can still benefit from specialization and trading with Country A.

  The law of comparative advantage is popularly attributed to English political economist David Ricardo and his book On the Principles of Political Economy and Taxation in 1817, although it is likely that Ricardo's mentor James Mill originated the analysis. David Ricardo famously showed how England and Portugal both benefit by specializing and trading according to their comparative advantages. In this case, Portugal was able to make wine at a low cost, while England was able to manufacture cloth cheaply. Indeed, both countries had seen that it was to their advantage to stop their efforts at producing these items at home and, instead, to trade with each other to acquire them.shikshasystem.blogspot.com

  The theory of comparative advantage helps to explain why protectionism is typically unsuccessful. Adherents to this analytical approach believe that countries engaged in international trade will have already worked toward finding partners with comparative advantages. If a country removes itself from an international trade agreement, if a government imposes tariffs, and so on, it may produce a local benefit in the form of new jobs and industry. However, this is not a long-term solution to a trade problem. Eventually, that country will be at a disadvantage relative to its neighbors: countries that were already better able to produce these items at a lower opportunity cost.