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International Trade

An exchange involving a good or service conducted between at least two different countries

What is International Trade?

International trade is an exchange involving a good or service conducted between at least two different countries. The exchanges can be imports or exports. An import refers to a good or service bought from abroad. An export refers to a good or service sold abroad.

 

International Trade

 

International trade is a method of economic interaction between international entities and is an example of economic linkage. Other forms of economic linkages include (1) foreign financial investment, (2) multinational corporations, and (3) foreign employees. The growth in these forms of economic linkages is known as globalization.

 

Summary

  • International trade is an exchange of a good or service involving at least two different countries.
  • Comparative advantage allows for gains from international trade, ultimately leading to increased consumption of goods.
  • Two major protectionist trade policies are tariffs and import quotas.

 

Why Does International Trade Occur?

International trade occurs because one country enjoys a comparative advantage in the production of a certain good or service, specifically if the opportunity cost of producing that good or service is lower for that country than any other country. If a country opts not to trade with other countries, it is considered to be an autarky.

If we consider a two-country model, both countries can gain from specialization and trade. Specialization and trade will allow each country to produce the product they possess a comparative advantage in and then trade, and ultimately consume more of both goods. Therefore, there are gains from trade.

 

Sources of Comparative Advantage

 

1. International differences in climate

International differences in climate play a significant role in international trade – for example, tropical countries export products like coffee and sugar. In contrast, countries in more temperate areas export wheat or corn. Some trade is even driven by differences in hemisphere.

 

2. Differences in factor endowments

Differences in factor endowments imply that some countries are more resource-rich than others in land, labor, capital, and human capital. According to the Heckscher-Ohlin model, a country enjoys a comparative advantage in production if the resources are abundantly available within the country; for example, Canada exhibits a comparative advantage in the forestry industry. It is primarily driven because the opportunity cost is lower for a country rich in the related resource.

 

3. Differences in technology

Differences in technology are most commonly observed in superior production processes seen in differing countries. For example, consider Japan in the 1970s – a country that is not overly resource-rich, yet enjoys a comparative advantage in automobile manufacturing. The Japanese are able to produce more output with a given input than any other country, and it comes down to superior Japanese technology.

 

Examples of International Trade Policies

Most economists favor free trade agreements because of the popularization of gains from trade and comparative advantage. It is because economists believe that government intervention will reduce the efficiency of the markets. However, it is a commonplace for politicians to introduce protectionist policies to protect domestic producers from foreign producers. There are two major protectionist policies:

 

1. Tariffs

A tariff is an excise that is paid on the sale of imported goods. Tariffs are put in place to discourage imports and to product domestic producers rather than to be a source of government revenue.

A tariff raises the price received by domestic producers, as well as the price paid by domestic consumers. Tariffs generate deadweight losses because they increase inefficiencies, as some mutually beneficial trades go unexploited, and some of the economy’s resources are wasted on inefficient production.

 

2. Import quotas

An import quota refers to a legal limit on the quantity of a good that can be imported within a country. Generally, import quotas are administered through the offering of licenses. An import quota leads to a similar outcome to a tariff; however, the tax revenue now would be considered quota rent. Quota rent is the license holder’s revenue.

 

Arguments for a Protectionist Trade Policy

The three major arguments for a protectionist trade policy are:

  1. National security
  2. Job creation
  3. Infant industries

 

Generally, tariffs or import quotas lead to gains for producers and losses for consumers. Therefore, the imposition of tariffs or import quotas is generally related to the political influence of the producers.

 

Additional Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Globalization
  • Non-Tariff Barriers
  • Excise Tax
  • North American Free Trade Agreement (NAFTA)

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