Countries trade for a variety of reasons, because trade is always more beneficial than not trading. Trading benefits both sides because both sides value whatever they are trading less than what they are trading for. So everybody wins. However, trade can conflict with a countries foreign policy, and such things as that, and that can interfere with how well the trade partenership works in the long run. These reasons for trade are examined on this page.
Differences in factor endowmentsEdit
Some countries can produce certain goods at a lower opportunity cost because they have resources that are more suited to produce the goods, this is a comparative advantage. However unless opportunity costs are exactly the same between countries, each will be able to produce certain goods at a lower opportunity cost relative to the other country. This comparative advantage means that one country can get a good at a lower price than they could if it were produced domestically. This means it is cheaper for them to import the good rather then making it themself.
However, there are some goods that fall border line and are domestically produced even though importing it would be cheaper. This could happen for a number of reasons, for instance if we import all of our country's bullets, and then go to war with the country we import from. If they stop exporting bullets to our country, our country will be at a loss for arms. There are some things that our country needs and wants and some things that other country needs. For example: good weapons for battle or better cars.
Variety and quality of goodsEdit
There are three basic levels of goods; primary, secondary, and tertiary, each containing a variety goods. Each country has their own personal primary goods that come from the 'land' factor of production in their country. Developing countries typically try to move away from producing primary goods and closer to secondary and tertiary goods. Primary goods are very income inelastic, which makes them wildly unpredictable and an unstable form of income. A small change in the quantity of a primary good will cause a great change in the price, making prices very unstable. Diminishing returns can make their value decline over time, because with each one produced it becomes more expensive and therefore less of a profit is made. That's not good for a developing country, because it leads to the poverty cycle, and is precisely the reason it's hard to have growth when only primary goods are produced.
Example: One example is oil. There are no oil wells in location A, but there are in location B. The people in location A would need to buy the oil from location B inorder to have oil. This creates trade relations with location A and location B.
Gains from specializationEdit
If countries each specialize in things that they have comparative advantages in, and then trade with each other, everything will be as efficient as possible. It is ineffiecient for a country that is bad at making shirts to produce shirts domestically. They should import shirts from another country that has a comparative advantage in making shirts. The country importing shirts should then export goods that it has a comparative advantage in producing.
Specialization can be seen by looking at the example to the right for a comparison between the production of balloons and plates in Brazil and Mexico.
As seen in the table, Mexico has an absolute advantage in making both plates and balloons. Absolute advantage is creating more of a good with the same amount of resources than a competitor. However, when you calculate the opportunity cost by looking at how much balloons you give up by making 1 plate or vice versa, each country has a comparative advantage. A comparative advantage is where the country uses less resources when making one good over the other, or has a lower opportunity cost. From the calculations, 1 Balloon costs two thirds of a Plate for Mexico, but it only costs half a plate for Brazil; thus, showing that Brazil consumes less resources for making Balloons. Brazil should make balloons even though Mexico can make more balloons in the same amount of time (absolute advantage). To have more of something means to sacrifice a part of another item.
The main gain from specialization is that more is produced using the same amount of resources and both countries can increase total consumption. (Each country should produce the good that they have a comparative advantage in)
Trade can create beneficial connections and alliances between countries. By working together and combining their strengths, countries are able to produce a greater amount of goods more efficiently and everyone is better off because we all benefit. This leads to a spillover of sociopolitical influence. Also, increase in trading leads to an increase in exporting and importing, which is generally beneficial to a countries GDP. Examples of the political benefits can be seen in free trade agreements. The North American Free Trade Agreement was passed in part to help bolster ties between North American countries.
However, trade can also be the cause and sometimes even source of unrest and conflict between two countries. Suppose country A and country B have been trading goods for mutual benefit. Country A decides to go to war with country B, for whatever reason. However, country B has been getting its military supplies from country A. Country A will no doubt sever their trade ties with country B, and along with the military goods. Because of this, country B will not be able to fight back, and is essentially defenseless.
Limitations to the Theory of Comparative AdvantageEdit
One of the main limitations to the theory of comparative advantage is that in most cases it isn't sustainable. That is, if one of the countries is a developed country, they are mainly producing primary goods. While in the short run the theory will hold true, and trade will take place, the theory falls apart as the good begins to become scarce, as is inevitabe with primary goods. The opportunity cost will get greater and greater as time goes on, to a point when, as the resource runs out, it is infinity, at this point the model no longer works. There is also the idea of capitol being mobile internationally, which states that if capitol is mobile, which most is, the capitol can move to a country where the labor is readily available to produce using the capitol at a lower price (outsourcing). This is no longer a comparative advantage, but is not an absolute advantage for the country producing.
The Theory of Comparative Advantage assumes the premise of homogeneous goods, zero transport costs, no barriers to trade, constant opportunity costs, and neglects benefits of scale. Due to these assupmtions, the theory is often criticized. Such critics also argue that while a country may initially be comparatively disadvantaged in a given industry (Japanese cars in the 1950s, for example), countries can shelter and invest in industries until they become globally competitive. Further, they argue that comparative advantage is a static theory, one that does not account for the possibility of the advantage changing through investment or economic development, and thus it does not provide guidance for long-term economic development.