Trade
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Advantages of international trade
One of the key advantages of international trade is gains of trade based on comparative advantage. Comparative advantage states that countries should specialise in the goods and services of which they are comparatively better at producing (Begg and Ward 2004). A country has comparative advantage over another in the production of a good if it can product it at a lower opportunity cost (Sloman and Hinde 2007). It normally arises from an abundance of a particular factor resource, e.g. France is good at wine because of its abundance in productive land and climate.
For example, the production possibilities of 2 countries are as follows:
Country
Wheat
Cloth
Assume, pre-trade exchange ratio of wheat for cloth are
Country A: 2 wheat for 1 cloth
Country B: 1 wheat for 2 cloth
Country A gains by exporting wheat and importing cloth. Country B gains by exporting cloth and importing wheat. Thus both countries have gained from trade. Gains of trade between the 2 countries need not be equal as it depends on the relative prices of wheat and cloth after trade takes place.
Terms of trade is defined as the price index of exports divided by the price index of imports and expressed as a percentage (Sloman and Hinde 2007). If terms of trade rise, they are said to have improved, since fewer exports now have to be sold to purchase any given quantity of imports. Changes of terms of trade are caused by changes in demand and supply of importers and exporters and changes in exchange rate.
Other advantages of international trade