Reasons for Trade

The first theory section of this course contains explanations or reasons that trade takes place between countries. The five basic reasons why trade may take place between countries are summarized below. A variety of models are described which offer a reason for trade and the expected effects of trade on prices, profits, incomes and individual welfare.

Differences in Technology

Advantageous trade can occur between countries if the countries differ in their technological abilities to produce goods and services. Technology refers to the techniques used to turn resources (labor, capital, land) into outputs. The basis for trade in the Ricardian Model of Comparative Advantage is differences in technology.

Differences in Resource Endowments

Advantageous trade can occur between countries if the countries differ in their endowments of resources. Resource endowments refers to the skills and abilities of a country's workforce, the natural resources available within its borders (minerals, farmland etc.), and the sophistication of its capital stock (machinery, infrastructure, communications systems). The basis for trade in the Pure Exchange model and the Heckscher-Ohlin Model is differences in resource endowments.

Differences in Demand

Advantageous trade can occur between countries if demands or preferences differ between countries. Individuals in different countries may have different preferences or demands for various products. The Chinese are likely to demand more rice than Americans, even if facing the same price. Canadians may demand more beer, the Dutch more wooden shoes, and the Japanese more fish than Americans would, even if they all faced the same prices.

Existence of Economies of Scale in Production

The existence of economies of scale in production is sufficient to generate advantageous trade between two countries. Economies of scale refer to a production process in which production costs fall as the scale of production rises. This feature of production is also known as "increasing returns to scale."

Existence of Government Policies

Government tax and subsidy programs can be sufficient to generate advantages in production of certain products. In these circumstances, advantageous trade may arise solely due to differences in government policies across countries.

International Trade Theory and Policy - Chapter 30-0: Last Updated on 7/18/06