International economics 4.1 Reasons for Trade International economics

Why do countries trade? It could be argued that in many of the modern countries any product/service could be produced. If this is the case why do countries not produce all possible good/services?

Difference in Factors of Endowment Each country (sometimes limited to a region of the county) has an abundance of land = soil/ climate, labor, and capital that other countries do not have. We buy pineapples from Thailand (climate) cars from Japan (skilled work force) and cough medicine from Switzerland (capital investments in medical research)

Relative factor endowment It is not that you could not grow pineapples in Norway or make cars in Tanzania, it just is the amount of resources the county would have to give up in order to do this would not make it worth while.

Countries are differently endowed with the factors labor and capital and will have different cost rations in the use of these factors. The higher the relative abundance of labor compared to to capital = the lower labor costs. Developing countries have more labor relative to capital and developed countries have the opposite.

Anything that is labor intensive tends to be made in a developed country and products that at technologically driven will of course then be made it developed countries. Countries will produce and export goods in which they are relatively well endowed with appropriate factors because the goods will be produced relatively cheaply because of the abundant factors

The gain of course is that by trading the countries can consume more that would be possible if it was only produced for a domestic market.

Variety and Quality of Goods Trade however still takes places between countries with similar factor endowment. Non –price theories of trade – consumers want choice and diversity of products. Add to this the theory of non-price competition means that consumers are willing to pay a higher price for these choices.

Branded goods (Nike, Apple etc) will also sell in countries that will domestically produce the same good. Nike = Adidas, Sony = Philips etc Firms must continue to try and show how they are different in a market of homogenous goods.

Choices and freer markets enhances competition. Countries that have high trade barriers usually create a situation where both productivity and allocation efficiency is sub – optimal. Firms that are forced to be competitive in their home market are usually also successful when it come to exporting to other markets.

Gains from Specialization The ultimate goal of trading is a “win win” situation – both sides should feel like they have benefited from the exchange of goods. By specializing producers are able to produce a superior good, at a cheaper price (economies of scale) so trading then because vital to obtain good that are not produced by oneself / town / region / county (you get the picture)

The economies can produce and consume anywhere along the PPCs, in accordance with our assumptions. Capitalia starts out at point A (diagram I), producing and consuming 100 units of capital goods and 75 units of consumer goods; Consumentia is at point D (diagram II) producing/ consuming 75 units of capital and 100 units of consumer goods.

Assume now that each country were to specialize in the production of one good . Capitalia specializes 100% in producing capital goods, point B, and Consumentia puts 100% of its resources into producing consumer goods, point E; Capitalia would have no books, or shoes, while Consumentian farmers would be harvesting wheat and drilling for water using sharp sticks.

This is of course where trade comes in This is of course where trade comes in. Capitalia’s domestic demand for capital goods is 100 units, and therefore it has 100 units with which to trade for consumption goods — shown by the X (export) and double-arrow in diagram II. Note that if Capitalia ‘gave up those 100 units of capital on a closed domestic market, the liberated resources could be put into the production of consumer goods and the economy would be back at point A; production and consumption would be comprised of 100 units of capital goods and 75 units of consumer goods.

However, after lengthy negotiations, Capitalia manages to get rather a good deal on its capital goods; 1 unit of consumption goods for 1 unit of capital. Trading the surplus 100 units of capital renders the citizens of Capitalia 100 units of consumer goods for domestic use — shown by the arrow at M (imports) Capitalia is now at point C, and the gains from trade are quite evident in the distance between points A and C. Opening up the economy to trade has benefited the domestic economy by 25 additional units of consumer goods.

Citizens in both of the countries will benefit from the trade as there will be more wants satisfied. In the long run both of these countries will actually be able to shift their PPC curve outward because of trade.

Production Gains If an economy focuses on a relatively narrow range of goods, over time they should benefit from an increase productivity due to experience and productivity. These gains are usually reinforced over time and the PPC pivots in favor of capital.

Capital goods Consumer goods

Even a country with very little domestic resources will benefit from specialization because of economies of scale and increased use of technology will lower the average cost per unit. Open markets have increased trade increased specialization and contributed to the growth of goods that are largely or in some case solely produced for the export market

Political Many of the countries today have trade agreements with other countries or are members of some type of trading group of countries European Union was started originally as the European Steel and Coal Community – they chose steel and coal because they are some of the main economic factors of both WWI and WWII.

The success is evident that Europe today tends to work together as a trade block and not against each other on the battlefields. Japan, S Korea, and China all have improved relationships based on trade. Some historian (and a few economist) would argue the the collapse of the Communist Eastern Europe was linked to trade and the demand of their citizens to freedom of choice in trade and in government.