International trade is the exchange of capital, goods, and services across international borders or territories. Trading-partners reap mutual gains when each nation specializes in goods for which it holds a comparative advantage and then engages in trade for other products. In other words, each nation should produce goods for which its domestic opportunity costs are lower than the domestic opportunity costs of other nations and exchange those goods for products that have higher domestic opportunity costs compared to other nations .
International Trade
Countries benefit from producing goods in which they have comparative advantage and trading them for goods in which other countries have the comparative advantage.
In addition to comparative advantage, other reasons for trade include:
- Differences in factor endowments: Countries have different amounts of land, labor, and capital. Saudi Arabia may have a lot of oil, but perhaps not enough lumber. It will thus have to trade for lumber. Japan may be able to produce technological goods of superior quality, but it may lack many natural resources. It may trade with Indonesia for inputs.
- Gains from specialization: Countries may gain economies of scale from specialization, experiencing long run average cost declines as output increases.
- Political benefits: Countries can leverage trade to forge closer cultural and political bonds. International connections also help promote diplomatic (rather than military) solutions to international problems.
- Efficiency gains: Domestic firms will be forced to become more efficient in order to be competitive in the global market.
- Benefits of increased competition: A greater degree of competition leads to lower prices for consumers, greater responsiveness to consumer wants and needs, and a wider variety of products.
To summarize, international trade benefits mostly all incumbents and generates substantial value for the global economy.