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Home Theory of International Trade Origin and Purpose of International Trade

 

Origin and Purpose of International/Foreign Trade:

 

Trade between different countries takes place because it is to their mutual advantage. The main conditions under which international trade is profitable are as follows:

 

(1) If a country is enjoying a monopoly in the production of a certain commodity, it will have an absolute advantage in the production of that commodity over other countries. The other countries will find it advantageous to buy that commodity from that country. Brazil for instance, has an absolute advantage in the production of Coffee, South Africa in Diamonds and Gold, Italy in Lemons, U.S.A. in Copper, Canada in Nickle, Mexico in Silver, Scotland in whisky. The countries in which these commodities are not found or they cannot produce it due to unfavorable climate or of soil obtain them through exchange of goods and thus enjoy wider range of commodities.

 

(2) International trade takes place because of the differences in the productive possibilities of different countries. If each country tries to produce all the commodities which it needs, it will not be able to do so and if at all it succeeds, it will be done at an enormous cost. Adam Smith in his book 'Wealth of Nations' writes:

 

"By, means of glasses and hot walls, very good grapes can be raised in Scotland and very good wine too can be made from them at about thirty-two times the expense from which at least equally good wine can be brought from foreign country".

 

We find thus that if any country tries to produce a commodity or commodities for which if is not best fitted, it will involve unnecessary heavy expenditure. The best way for country is to concentrate on the production of those commodities which it can produce at a lesser cost than the other countries. If a country tries to produce a commodity or commodities for which it is not best fitted, it will have to incur unnecessary heavy expenditures. This waste of resources can be avoided if all the countries concentrate in the production of those goods for which they are best suited and trade them for other goods which they need from other countries.

 

(3) Trade between two countries is mutually profitable even when one country is in a position to produce the goods at a cheaper rate than the other country. For instance, if country 'A' and country 'B' both produce cotton and wheat, if country A produces cotton more cheaply than B, it may prove advantageous for country A to specialize in the production of cotton because it has comparative advantage in its production.

 

(4) Adam smith, unlike Mercantilist, was not in favor of putting artificial restrictions on trade between countries. He was of the view that nations should trade freely with each other as they are blessed with different resources. According to him, if nation's specialize in the production of those commodities for which they have an absolute advantage, they will gain by trading with each other. For example, with a given labor cost, country A can produce 10 quintals of wheat or 20 quintals of jute. Country B, with the same given labor cost can produce 5 quintals of wheat or 40 quintals of jute.

 

Here country A is efficient in the production of wheat and country B has the absolute advantage in the production of jute. So if country A specializes in the production of wheat and country B in the production of jute, then both the countries will gain from mutual trade.

 

David Ricardo, a British classical economist, further refined this version of international trade put forward by Adam Smith. According to him:

 

"Trade between two countries is beneficial even if one country is efficient in the production of both the goods over another. Here, both the countries will gain most when each country specializes in the production of those commodities for which its comparative or relative costs of production are lowest".

 

This is in nutshell the Principle or Theory of comparative Cost.

Relevant Articles:

Home Trade and International Trade
Foreign Trade and National Income
Origin and Purpose of International Trade
Theory of Comparative Cost
Gains From International Trade
Modern Theory of International Trade
Terms of Trade
Advantages and Disadvantages of International Trade
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

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